Intercommodity Spread

Hashtag truth: trading isn’t always about price. Sometimes it’s about direction. And when it comes to commodities trading, we can capitalize big-time if we correctly predict the direction the value of that commodity is going to move.

Let’s take this discussion to the next level and talk about what can happen when we start dabbling in spreads that involve not one but two commodities...specifically, commodities that are different but related. We’re not talking about the false dichotomy between left and right Twix bars, but things that are actually different and related. Maybe they’re not quite substitute goods, but they’re real close. Cotton and hemp. Oil and gas. Dan and Shay. Okay, we can’t trade Dan and Shay. But we can make ourselves some pretty nifty intercommodity spreads when we play with different-but-related commodity trading options.

What’s an intercommodity spread? It’s when we take a long position (i.e., we buy) on one commodity, like hemp, and a short position (i.e., we sell) on a related commodity, like cotton, during the same delivery period. In this scenario, we’d do this because we expect the gap between the higher-priced hemp and lower-priced cotton to widen. If we expected it to narrow, we’d take a short position on hemp and a long position on cotton. We’re less interested in the actual price of each than we are with the difference between the two prices and whether the gap is widening or narrowing. That’s what we’re betting on: the difference and direction.

Commodities investing can get tricky and is not recommended for novices or the faint of heart. The most successful commodities traders know more than a little about the commodities they deal with, so if intercommodity spreads sound like they just might be our cup of tea (another commodity, FYI), then we should definitely do some serious research before taking a sip.