Spread Trading Gold Vs Platinum

Many customers have been asking spread strategy questions and last week's action in the gold and platinum markets provides us with a wonderful opportunity to have this discussion.

The chart at the end of this article will provide more detail.

The red line on the bottom is how much gold is worth relative to platinum (gold close/platinum close). This is a monthly chart and you can see that the spread, along with platinum, have broken their trends going back to '01. This means that the prices of these two metals are converging. One should be short platinum and long gold. The way I see it, the price of platinum has been beaten up far worse than gold. I think the global slow- down scenario may be impacting the manufacturing base for platinum more than inflationary/deflationary issues are effecting the speculative nature of the gold market. Gold has also held above its trend line, in spite of the U.S. Dollar's significant rally.

Profitable spread trading requires more than predicting the general directions of the two markets involved. The size of the contracts, tick size and volatility also need to be considered. In this example, there is only one platinum contract to choose from. However, there are four actively traded gold contracts in three different sizes and on two different exchanges. Even the simple assumption that one full size contract of each should be sufficient would be incorrect. Recently, platinum is moving around $67 per day in the futures market and gold is moving around $25 per day. Would it be appropriate to try to even these out by trading two gold contracts versus one platinum contract?

Here is the method I use to appropriately size my spread trades. First of all, I calculate the average range for each market relative to the time frame I expect my trade occur in. In this case, I am looking at monthly charts. Therefore, I calculate the 21 day average range for each market and come up with $21 for gold and $67 for platinum. The next step is to multiply each of these average daily ranges by the market's point value. Gold is $21 X $100 = $2100 per day average movement. Platinum gives us $67 X 50 = $3350 in average per day movement.

Clearly, one full size contract of each is not an even spread. Now, since we know that we only have one platinum contract to work with, our only opportunity for proper sizing in the futures market (there are option strategies available, as well), is to look at the list of available gold contracts. One full size gold contract gets us to $2100 per day and leaves us with a $1200 per day deficit to make up. Chicago's mini sized gold contract is 33.2 oz. (1/3 full size). That would bring our total to $2793 on the gold side of the trade. This won't square the ledger. New York's mini sized gold contract is 50 oz. (1/2 full size). That would make our total $3150. That's pretty close. Obviously, the other option is to use two Chicago mini contracts and bring our total to $3486. At this point, it comes down to personal bias. Would one rather be more or, less long gold relative to platinum.

I hope this brief description answers more questions than it creates. However, please feel free to post any ideas, comments or, issues.

For further illustration. blog.commodityandderivativeadv.com/2008/09/09/spread-trading-gold-vs-platinum.aspx

This post was made using the Auto Blogging Software from WebMagnates.org This line will not appear when posts are made after activating the software to full version.