Mike "Beef" from the Research Team discusses with Tom and Tony some of the professional strategies he use to implement during his days as a prop trader. He dives deep into a new strategy now available for retail traders known as a future calendar spread.

Tony: Thomas, we're back, my friend - closing the gap futures edition.
Tom: Alright, perfect.
Tony: How are you, Beef?
Mike "Beef": I'm good.
Tom: All right.
Tony: Are you sure about that?
Tom: What do you mean?
Tony: Of course you're good.
Mike "Beef": I'm great.
Tom: Good. No Pete today, he is off taking his kid back to school, and so we are … So Beef is filling in.
Mike "Beef": Yeah. Going in house.
Tom: Going in house. I like it, I like it a lot. You guys look like you put together a lot of stuff here.
Mike "Beef": We did, this is a great segment.
Tom: I have a couple of trees here as far as content but I'm really looking forward to this. You know, in all the years of trading that I've done a lot of futures calendar spreads. I know that's the topic you guys are going to be focusing on today but I think you know maybe we've done a couple in soy beans and maybe we’ve done a couple in the bonds.
Tony: It's been a long time.
Tom: For the most part I rarely trade futures calendar spreads and I called around yesterday to a bunch of friends just to see how active people are in that space right now and I couldn't find a lot of activity but I can't find a lot of activity any where right now.
Mike "Beef": Well, on a professional level.
Tom: Yeah.
Mike "Beef": It's pretty much all we traded.
Tom: Yeah.
Mike "Beef": They're finally accessible to the retail public.
Tom: The retail investor.
Mike "Beef": Yeah.
Tom: Yep, I didn't realize how huge the margin savings was. Now I think it's interesting but if this is your first time on tastylive this is a segment that we do once a week on Fridays called closing the gap. It's institutional strategies for retail investors, on bi-weekly, we do futures one week and we do securities the next week.
Mike "Beef": Mm-hmm (Affirmative).
Tom: Like next Friday we'll do a securities edition which will be institutional stock and options strategies for retail investors. Today, we are going to do futures strategies. Usually our guest is the director of education at the Merk, but again he is not there today so sitting in for him is our own Beef.
Tony: That's correct, that's a strategy that you've used often in your trading career, right?
Mike "Beef": What's that?
Tony: The calendar spread.
Mike "Beef": For 8 years that's pretty much all I trade in. I've traded millions of calendar spreads.
Tom: Millions?
Mike "Beef": Millions.
Tom: Millions of calendar spreads.
Mike "Beef": Millions. I've traded a million in 1 year.
Tom: You traded a million calendar spreads in 1 year?
Mike "Beef": Yes!
Tom: Wow. That sounds like a lot. A million calendar spreads.
Mike "Beef": On a professional level it's a very liquid market and even on the retail level. [crosstalk 00:02:37]
Tom: Yeah I guess millions probably makes sense but it's not millions of trades it's millions of contracts.
Mike "Beef": Millions of contracts.
Tom: Right. Alright, well then I guess you're the expert here because I think I've traded 10.
Tony: I might be in the single digits.
Tom: Yeah, yeah but the reason being is I never had the capital relief.
Mike "Beef": Right.
Tom: When you're professional [inaudible 00:02:59] the reason you could trade millions was that it required virtually zero capital.
Mike "Beef": Basically, yeah absolutely.
Tom: If you're never a member and I never was a member of this particular exchange then it's expensive.
Mike "Beef": Correct.
Tom: Professional oil strategies we're doing calendar spreads today and so Beef for starters in the commodity space, crude oil is a highly liquid and very active marketplace. Tony, Katy, even Case has a position on there now. I have a position on crude oil so I think throughout the years it's been people have a difficult time getting their arms around futures options but now it’s become much more popular. They're in demand, it's high volatility, lots of liquidity. It's an interesting underline.
Mike "Beef": Absolutely, yeah.
Tom: One thing about some commodities is the underlying is more interesting.
Mike "Beef": Of course.
Tom: Yeah, I mean it's really hard for me to get my arms around really I want to do a position under armour or sales force dot com. Yeah know, those are hard to get your arms around. Crude oil is a little easier to get you arms around. Until recently retail investors didn't have access to many of the products used by professionals, including calendar time horizontal spreads.
Mike "Beef": Right.
Tom: However you want to do those. So what we have up here is a little graph of the price of crude oil and then it's also the volatility in crude oil.
Tony: Right.
Mike "Beef": We just put that up there, these are the things that we consider are the volatility are where the price is at.
Tom: Right.
Mike "Beef": Yeah.
Tom: Right now we have relatively low crude volatility.
Mike "Beef": Correct.
Tom: And we have a declining price.
Mike "Beef": Recently declining.
Tom: Recently declining price. A calendar spread is the price differential between the front (nearest to expiration) contract and each corresponding futures contracts. A positive spread means the product is trading backwardation, where a negative spread means the product is trading in contango.
Mike "Beef": Right.
Tom: We have discussed this many times but backwardation just means that the front month future his higher in price than the back month. So, it's like a backwards slope.
Mike "Beef": Right.
Tom: Contango is a forward slope.
Mike "Beef": Exactly, so in the future for, there's several reasons you can't pin it down to 1 reason why the price is lower in the future but the market is speculating a lower price in the future so we see right now a backwardated market and this graph up here illustrates that.
Tom: Cool graphs you guys are putting together.
Mike "Beef": Right, it's pretty neat.
Tom: Near months are more expensive and the spread between the near and far months has become wider. A visualization of the widening of the oil spreads as the market becomes more backwardated.
Mike "Beef": Right, so if you look back to June of 2012 it was very tight we weren't quite in contango but it was very close to being either backwardated or in contango and now we are definitely in a backwardated market and it's expanding and recently we've seen a decline.
Tom: I want everyone to be clear about this there's not necessarily any kind of a theoretical edge this is more of a reversion to the mean price. Otherwords, you are looking at a spread and a lot of our discussions are going to revolve around reversion to the mean. Isn't that right?
Mike "Beef": I think so. Yeah.
Tom: We are not going to get into the fundamental reasons why may be higher in the front month now because some people say you need to focus on the fundamental reasons why. We're one of those that believe the fundamental reasons are already built into the pricing.
Mike "Beef": Especially in oil all that stuff doesn't matter, it really doesn't. It all these stories …
Tom: It's hard to base a trade
Tony: On one thing.
Tom: Off something you may thing might happen in the Ukraine. You know what I mean?
Mike "Beef": Right.
Tom: It's a very difficult fundamental argument for making a trade. The argument here is that you're here looking at this and you are going, wow, a year and a half ago or 2 years ago we were trading when the spread was this big and now the spread is this big and we're hope at some point that there is some return to the mean or some normalization of that spread.
Mike "Beef": Absolutely.
Tony: Opportunity, that's all your hopping for.
Tom: There is a lot of stuff in here so you have to be careful. Year spreads are actively monitored by traders thought they carry a great deal of delta risk than shorter spreads. I mean that's obvious but the longer you go out the more duration you have time to be right but of course the greater the risk you have that you're making the fatal failure.
Mike "Beef": Right and what we are showing here is the December to December contract. Effectively you have an entire year, when you are long the front Dec and short the back Dec you have an entire year of duration. That's why it carries more risk. If you had a December to January contract, much less risk. Just stating the obvious I guess.
Tom: Yeah OK. That's a better way to put it, Stating the obvious. Oil spread are often highly correlated to the price movement in the oil market.
Mike "Beef": Yes.
Tom: When we say the market we mean, in this case the oil market. We are still trying to figure out the correlation to the stock market, cause right now if you looked at it you would say it is inverted right. But hasn't necessarily been the case over time. We used to look at the oil market and say oil's down, stock's down, oil's up, stock's up and now we are looking at the market going oil's down, stock's up
Mike "Beef": Right.
Tony: Right.
Tom: That doesn't make any difference, but the spread itself can be highly correlated to the price on the market which means that the spread itself may have some kind of directional correlation to the width of the spread.
Mike "Beef": Absolutely and you know as a potential trade strategy if say oil spikes for whatever reason you think it is a good sale you could go into the spread market. You are taking on less risk in the spread market.
Tom: We are going to show in a second why you can go into the spread market in this case because it is going to be a lot about capital. Future calendar spreads trade as a separate product aside from the outright future contract. The active months tend to have liquid, have tight bid to ask differentials. This allows for future calendar spreads to be entered as one order, eliminating legging risk. Here's an example: And if I am correct do they trade inside of the listed markets or do they trade at the minimum tick level?
Mike "Beef": What do you mean by that?
Tom: Meaning is there an inside spread market or is it just the minimum tic between the two, like one tick?
Mike "Beef": It's inside spread markets so it trades separately it's its own contract. Think of it as its own product. Every spread has its own product.
Tom: If the bid/ask differential for oil is $10 let's say, the tick price.
Tony: Between the futures.
Tom: Yeah, between the futures. How much is the spread price, you know [inaudible 00:09:57].
Tony: Would you like to take a look?
Tom: What?
Tony: Would you like to take a look?
Tom: Sure.
Tony: Put it up there.
Tom: OK, That's cool.
Tony: Yeah, OK.
Tom: Wow, I'm really learning a lot actually today, I like this.
Tony: You can go to. I just have CL in here. I'm going to go from Active Only, I'll just show all three months just so everybody can see it. Then I'll change single to calendar, and then I'll right click and go to buy for argument sakes. Buy Calendar, and it'll pop up. You see it's 85 cents. You're looking at October-Jan here, you can change it to whatever you want to do.
Tom: Right. It's per tick, right? Per cent, penny?
Tony: Yeah
Tom: It's still the $10.
Mike "Beef": So, if you show. Tony, if you click the arrow all the way over and expand the box down.
Tony: There you go.
Mike "Beef": Alright, so yeah, now you can see.
Tom: The spread markets.
Mike "Beef": These are the various spreads.
Tom: Oh wow.
Mike "Beef": So, October. The first one you see, going downwards, I actually just bought this. Before I came in the room I just bought the October-November oil spread.
Tom: What'd you pay for it?
Mike "Beef": I paid 48 cents.
Tom: You paid 48 cents?
Mike "Beef": Yeah, it was bid at the time. So yeah, it's
Tom: It's 46-47, right?
Mike "Beef": Right, so if you wanted to buy it you could just buy the 47, You can see the size listed, there's 200 bid right now, offered at 78. Right now this is actually quite thin for this spread, this spread can get very heavily bid and offered where it doesn't move, but we're seeing a period right now where the spreads are fairly active.
Tom: 47 to 48 is $10?
Mike "Beef": 47 to 48 is $10. Yeah, it's $10 a tick.
Tom: $10 a
Mike "Beef": Per 1 lot.
Tom: Per 1 lot.
Mike "Beef": A 1 lot, if it moves 1 penny it's a tick. So every tick is $10.
Tom: I haven't used this bat but now I am all intrigued.
Tony: Uh-huh (Affirmative).
Tom: I can't believe this and the margin is
Mike "Beef": These things are moving right now, there is a lot of
Tom: How much are they moving today?
Mike "Beef": Well right now down 11 ticks is quite a big move for the front oil spread.
Tony: Right but that is because oil is down 1%.
Mike "Beef": You could pull up a chart real fast. If you click on the blue button, there.
Tony: Yep.
Mike "Beef": Then, yeah.
Tony: Now just hold on I've got to. You won't like the chart what it looks like so I have to
Mike "Beef": You have to go to a different page.
Tony: Yeah but I've got it. You’re not going to like what it looks like or everything else like that.
Tom: That's your spread.
Mike "Beef": That's the spread.
Tom: Interesting. In the marginal [inaudible 00:12:16] it's only a couple of hundred dollars.
Mike "Beef": $450, around for a 1 lot.
Tom: Wow, this is great. This is an amazing session because this is all stuff I've never really used before even on the software. And I don't know why I haven't traded a lot of these spreads but I haven't.
Tony: For those who don't know how I was able to bring it to a chart
Mike "Beef": No just go back to the spread, show the whole thing. Take it though the whole process.
Tony: OK.
Tom: One of the coolest things about toss is just the ability to do anything on the software that you can never do as a retail [crosstalk 00:12:50]
Mike "Beef": The idea that this is available to the retail, is to me like amazing. The fact that this is available is a huge breakthrough.
Tony: This probably actively set up, I'm going to change it to 3 months, you can change it to all if you like. Load it from single to calendar, as Beef said click on the little arrow to the left hand side I can show all of the different markets.
Tom: I am going to go to 3 months, I'm going to go to calendar. I'm going to go to click on this.
Mike "Beef": What'd you click on, October?
Tom: Just clicked on October. And the market's 46-47.
Mike "Beef": That correct.
Tom: I have not traded this Mike in a while but I'm going to try this. Just go. Boom, okay. So I paid 47.
Mike "Beef": Beautiful.
Tom: Just out of the same spread you did and
Mike "Beef": That would be …
Tom: I don't know how we are going to put this through Bob yet.
Tony: I'll see how it comes through.
Tom: Yeah see how it comes through.
Tony: I might not have the programming correctly, but I will take a look.
Tom: I traded it small. I just did it because it's the first time I've done it on the [inaudible 00:14:02]. I can't believe it's so simple
Tony: This is buying October selling November, correct?
Tom: Yeah.
Tony: When you’re buying it, OK.
Tom: It just went bid for you, that's nice.
Mike "Beef": That's great.
Tony: Now that's if you can scratch it.
Tony: If you want to send it to a chart you just click on the blue circle. And you go down and set it to toss charts and then you just click on the left hand side, that's all you've got to do.
Tom: It's a little bit different than calendar spreads that we do with equities, because with equities we're always selling in the front month and buying a month out.
Mike "Beef": Yeah.
Tom: In this case we're buying the near term and selling the farther term.
Mike "Beef": Right. We'll go to the next page and I'll walk through
Tom: Futures calendar spreads trade as a separate contract aside from the outright future. Active months tend to have liquid, tight bid/ask differentials. This allows for future calendar spreads to be entered as one order, eliminating leg risk. Here is the example: And we just did this right now.
Mike "Beef": We just did this. In this example we are actually selling so you see the spread prices. This was yesterday it was at 60 cents right.
Tony: Now it's 47.
Mike "Beef": Now it's 47, so yesterday if wanted to sell it … If you think the spread price is going to go down you would sell the October, buy the November. That's if you think the spread price is going to go down.
Tom: See that's the way I want to play it, but I do it the wrong way.
Mike "Beef": Well if you think the spread price is going to go up then you would buy the October.
Tom: I want to play it for the spreads to contract. So I should be selling October and buying November.
Mike "Beef": That's right. I am playing it the opposite way. But …
Tom: I played it the wrong way for what I think should happen.
Mike "Beef": For what you think. Yeah.
Tom: Usually if I do the opposite of everything I think then
Tony: It George Castanza day.
Tom: Yeah, It's George Castanza day. Well I'll change this around and flip-flop it over because [crosstalk 00:15:37].
Tony: And a 20-25 tick is a big daily move in there.
Mike "Beef": Yeah, it big but right now we're seeing more volatility in the spreads. This, actually, could mean more volatility coming in the future for crude. It's a good indicator.
Tom: Yeah I want to do it the other way but I will switch it up after the show.
Mike "Beef": OK.
Tom: Here are the contract specks for the front 1 month calendar spread.
Mike "Beef": This is just what we looked at, basically.
Tom: Beautiful.
Mike "Beef": Yeah.
Tony: It came through nice on Bob, so you didn't see that.
Tom: I'm not sure that I did it backwards from the way I wanted to do it. Because I wanted to bet on the bid contracting. But put it through that's fine we'll take it off … Then we'll put it on and then we'll take it off and see what happens. It'll give us some practice using it. Cause I want to bet on the spread.
Tony: You think the spread is going to keep going down.
Tom: I want to bet on the spread contracting.
Mike "Beef": Right.
Tom: Right. It's going to be short October-long November.
Mike "Beef": It's at 48 right now you think it's going to 38-28.
Tom: Right.
Mike "Beef": Perfect. Then you want to be short the front.
Tom: Right, I got it. Yeah.
Mike "Beef": You think it's going with the continuous slide that it's had.
Tom: No, I want to go the other way.
Mike "Beef": Then you have it the right way.
Tom: Well talk about this cause I'm confused then by that. OK we'll see. Here are the speck from the front one month calendar spread. This is what we talked about right?
Mike "Beef": I did this just to show this is its own contract. You're not legging into each thing, it's its own contract. It trades separately from the actual underlyings.
Tony: Yeah. This is the one thing that the futures exchanges did really well. Is create a separate contract for the bases. Which I like.
Mike "Beef": Yeah.
Tony: Now let's figure this out. Now we look at a calendar spread using the options on the crude oil with the October-November cycles. What you have here is out-of-money CALLS and out-of-money PUTS. Mike what are we trying to show here?
Mike "Beef": One, we're just trying to … Whenever I look at an option chain I, especially in commodities, I always check to see where their putting the skew. Where is the risk, and right now the PUTS are more expensive. The markets is in a way telling you that maybe the risk is a little bit more to the downside.
Tom: Is the PUTS skew, is the PUTS being more than the CALLS, is that normal in here? How do you know what normal skew is.
Mike "Beef": That's normal in crude. Actually.
Tom: Because I would think all of the risk in crude is to the up side.
Mike "Beef": The risk to the up side is when you see those very large moves. Then everything flips and it will stay like that for a period of time and then it reverts back to … This is generally what we have been seeing.
Tom: Cool. Then what we have here Tony this is the Calendarised Strangle, this is when you make the OCT-NOV trade but you just adjust the wigs.
Mike "Beef": Yeah.
Tony: It makes total sense.
Tom: The options don't trade as a spread.
Mike "Beef": The options do not.
Tom: The options trade as individual orders.
Mike "Beef": Right, and actually you won't get a margin relief by putting this trade on cause each contract, the way the market reviews it, is its own contract each future so you're not going to get the margin relief you would get if you did it in the same month. If you sold a strangle in just October
Tom: Yeah.
Mike "Beef": You get margin relief on the PUT column.
Tom: [crosstalk 00:19:04] but if you lose October/November then you are going to have to put it up for both. So this trade may cost $6000.
Mike "Beef": Exactly.
Tom: OK. Got it.
Mike "Beef": But, Yeah.
Tom: Right really interesting. And here's the CL options Calendar spread. OCT-NOV and these are using different strikes as well.
Mike "Beef": Different strikes as well but what we are doing is we're at delta Neutral for both. October's around at $94 right now November contract is trading around 93. You just go to be at the money for both. This is a play if you think volatility is going to expand.
Tom: If you think volatility is going … Yeah sure, yeah.
Mike "Beef": Yeah.
Tom: OK. Because you're buying a longer term option. You buy the end of the money option Or the closer to the money option.
Mike "Beef": Yep.
Tom: There's a lot of stuff here.
Mike "Beef": There's a lot. There's a lot.
Tony: There's a lot of new stuff for you too.
Tom: I'm a little confused right now. Now I'm not really confused, but I'm just like I haven't done
Tony: You're digesting it.
Tom: Huh?
Tony: You're digesting it.
Tom: Well I'm trying to figure out if I want the market to contract. How is selling the front month because that's the richer one, isn't it? Because we're in backwardation.
Mike "Beef": OK so the way I look at it is right now the spread was trading at 90 cents around there. [crosstalk 00:20:28]
Tom: Yeah, yeah I mean listen. You bought this. If you thinks it's going to continue going in the same way it's been then you would've wanted to sell it, right?
Mike "Beef": Right. If you … right now you think it's going up in the trade you have on right now, you think that chart's going to go up.
Tony: Long October and short November.
Mike "Beef": Yep. If you think it's going to continue to go down then you would sell October, buy November.
Tom: I understand all that. I'm just trying to think about
Mike "Beef": The spread between the two widening.
Tom: All right well I got the position I wanted. 47-48.
Mike "Beef": I got it on too. I like it.
Tom: Good, well now I've got all this new stuff to trade, it's going to be fun.
Mike "Beef": Yeah, this is just the tip of the iceberg.
Tom: Yeah. It's unbelievable. We're learning new stuff everyday. I love that. Cause you know I didn't even know that they were quoting the spreads direct on the software. Then can I send that to my market watch?
Mike "Beef": Yeah.
Tony: You should be able to.
Mike "Beef": Yeah.
Tom: That's cool. OK now I got to …
Tony: Now you've added something else to his market watch.
Tom: I can't believe how inexpensive it is to do. $400.
Mike "Beef": Yeah.
Tony: Yeah. That's going to be subject to span margin too, right?
Mike "Beef": It is. I've traded these for a long time so I've seen periods where extreme volatility in these does happen. Right now we are seeing some volatility but I would say it's a much safer play than just doing pure outright trades.
Tom: Awesome. Do you know what's funny is I just added by right clicking on the spread itself and right clicking on the spread going to add to watch list and then choosing which watch list I'm on and then throwing it out there so now it’s right in front of the screen.
Mike "Beef": Look at all this stuff. It's awesome.
Tom: Perfect, perfect, perfect. This is awesome. Thank you.
Tony: Good job to you Beef, we're going to take a quick break, we'll be back in 90 seconds, we got the opening bell next. You're listening to tastylive live.