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• Because a spread consists of two legs (buy and sell), one side could partially protect the other in case of adverse price movements. Let’s look at a quick example. A trader enters a spread position where she buys 1 gold contract with the delivery three months out at $305/oz. and sells 1 gold contract with delivery six months out at $310/oz., expecting the spread to narrow. If, however, within a week the first contract goes to $300/oz. while the second leg goes to $306/oz., the spread has increased by $1/oz., which is the amount per ounce the trader would be out. (If settled, the trader loses $5/oz. on the buy side, gains $4/oz. on the sell side for a net loss of $1/oz.). Still the trader is better off than if she just purchased the first contract (loss of $5/oz.). Now you may ask, what if the trader had just sold the other leg without buying the first leg? Yes, she would have realized a gain, but no one could have predicted for sure that the price of the gold contract would drop. It could have just as well risen, causing a loss.As it can be seen, the sell side (short) helped narrow the potential losses on the buy side (long) when the prices dropped and the spread widened. A similar protection would have been provided by the buy side against losses on the sell side had the contracts’ prices moved up and the spread increased.
• A spread trader does not care about the price direction of the contracts but the change in the magnitude of the spread. Spreads are great for those times when a certain commodity is expected to change in price but its direction is unknown. Believe it or not, this happens often when analysis predicts price movements but provides no conclusive hint on direction.
• If you have a short position and with the maturity date nearing you suspect that you have to make good on the delivery (or settle with a loss) because the price of the underlying product has moved unfavorably, you have the option to roll over the …