From the December/January 2013 issue of Futures Magazine • Subscribe!

ETNs are made for spreads

Spread trades between futures contracts present problems with equalizing the underlying prices. This is true with gold and silver because of the large differences in their cash and futures prices (see “Grain & cattle spreads: Finding an edge” (November 2011) and “Gold & silver: Always good options” (May 2011)). However, they also present opportunities. 

Consider a recent trading day in September 2012. The cash prices for these commodities were gold, $1,755; silver, $33.98; wheat, $8.34  and corn, $7.36. Wheat and corn futures almost are interchangeable and frequently shift the lead in price size. On the other hand, gold and silver are spread trade partners that require some effort to put their prices on an equal level. This equalizing is not necessarily an insurmountable burden; however, it can create uncertainty in trades where the slightest mismatch can mean the difference between profit and loss.

A trading alternative that eliminates most price discrepancy by design is the exchange-traded note (ETN). Because the companies issuing ETNs design the securities to be based on underlying commodities in a format that is easily traded on stock exchanges, the prices are set such that they are a convenient size for most traders. These new securities also have percentage price changes approximating those of the commodities or futures contracts on which their prices are based. In the case of gold and silver ETNs, the traditional ratio between the metals (51.6 in the current market) has been eliminated so that their ETNs may be traded with comparable prices. The ETN prices on Sept. 21 for these ETNs were gold, $46.72; silver, $48.72; wheat, $22.77 and corn, $19.88. 

Comparing markets

“Futures and ETNs” (below) shows how closely the ETNs follow the price changes of a single futures contract for both corn and wheat, and gold and silver. December futures are used in this study for each of those markets. Keep in mind that most ETN index prices are based on a mix of cash commodities and futures, as well as Treasury securities and other variables. Thus, December futures are used simply to show the relatively close correlation between ETNs and as a dependable benchmark price.

The charts indicate that for the period of April to mid-September 2012, the spread between gold and silver was much wider and potentially more profitable than the distance at any time between wheat and corn. In the previous study of the gold-silver spread, gold was stable and silver was the more volatile member of the pair. The current chart confirms this relationship to a surprising extent. Starting in early April, by the end of June silver had a cumulative percent price decline of almost 20%, while gold was stable with almost zero price change. Silver rebounded by 25% to become equal to gold later in September.

Silver futures and the silver ETN move together. A spread or hedge trade of silver vs. gold could have used either the ETN or December futures with approximately equal results. With the tight relationship between each ETN and its associated futures contract, a spread between the ETN and December futures would be difficult for all four commodities. This differs from the potential ETN-futures spread noted for the livestock ETN, COW, which is based on a combination of live cattle and lean hog futures (“Trading cattle, hogs and ETNs,” November 2012). The potential of an ETN-futures spread is better in that case because the ETN is based on more than one underlying commodity, which at times allows larger differences for spread trading.

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