How to do Lead Zinc Spread trading

I welcome visitors to this post.

In this post, I have written about Spread trading Leadmini and Zincmini. Spread trading is essentially taking advantage and capitalizing of difference of price between two different stocks or commodities. This price difference is referred as spread gap. I have selected Leadmini and Zincmini as example for various reasons. Leadmini and Zincmini often found in the same mines. Leadmini and Zincmini tend to move in the same direction but one commodity will be slower or faster than the other. This makes it an ideal pair to initiate a spread trade.  This type of trading is considered less risky because we go long on one commodity and short the other, depending on the market price action.  So, we are taking a hedge type position to say it in other words, we protect our capital or minimize our loss.

There are two types of spreads that will be discussed here. One is Bull spread and the other is Bear spread. 

A Bull spread is considered when the spread gap is expected to widen or the price to increase. A Bear spread is considered when the spread gap is expected to narrow or the price gets lower.

This strategy is not new.  I will try to explain with some examples. The data provided are MCX traded prices and the price quoted is in INR . The prices quoted are for mini lots. If you study the table below you can note that the spread gap varies on a day to day basis.

Date	Leadmini	Zincmini	Spread
11/1/2012	115.05	103.45	11.60
11/2/2012	113.30	100.10	13.20
11/3/2012	113.60	100.30	13.30
11/5/2012	116.80	101.25	15.55
11/6/2012	118.75	102.55	16.20
11/7/2012	119.05	102.20	16.85
11/8/2012	121.15	103.80	17.35
11/9/2012	118.75	103.15	15.60
11/10/2012	118.70	102.95	15.75
11/13/2012	118.75	104.05	14.70
11/14/2012	120.00	105.55	14.45
11/15/2012	121.00	106.20	14.80
11/16/2012	120.05	105.50	14.55
11/17/2012	119.95	105.35	14.60
11/19/2012	120.55	105.45	15.10
11/20/2012	119.60	105.05	14.55
11/21/2012	118.85	104.85	14.00
11/22/2012	119.50	105.15	14.35
11/23/2012	121.85	107.70	14.15
11/24/2012	122.05	107.80	14.25
11/26/2012	121.50	109.30	12.20
11/27/2012	122.20	109.35	12.85
11/28/2012	121.95	109.50	12.45
11/29/2012	121.95	110.20	11.75
11/30/2012	122.00	111.10	10.90

The Bull Spread explained

From the above chart note the prices of Leadmini and Zincmini on 11/1/2012 Leadmini is 115.05 and Zincmini is 103.45. The spread gap is 11.60.  Let us assume we enter a Bull spread trade here. Our trade will be -  we buy Leadmini at 115.05 and sell Zincmini at 103.45. From 11/1/2012 onwards we see the spread gap increases steadily. On the 13^th the spread gap is 14.70. Here the spread gap difference becomes 3.10 (14.70-11.60). We decide to close the trade at this point. Now we have to sell what we have bought and buy what we sold. So we sell Leadmini at 118.75 and buy back Zincmini at 104.05

	Bought	Sold	Profit/Loss
Leadmini	115.05	118.75	3.70 ( Minus Rs.3,700)
Zincmini	104.05	103.45	-0.63  (Rs. 600)
Total profit  3700-600			Rs 3,100

This Bull spread trade we have a profit of Rs. 3,100  

The Bear Spread explained

On the 20^th the spread gap stands at 14.55 and we sell the Leadmini at 119.60 and buy Zincmini at 105.05.  Towards the end of the month that is on the 29^th the spread gap is 11.75. Here we have to close the trade because the month end and advantage of spread gap difference. We buy back the Leadmini at 121.95  and sell Zincmini at 110.20 to close the trade.

	Bought	Sold	Profit/Loss
Leadmini	121.95	119.6	-2.35 ( Minus Rs.2,350)
Zincmini	105.05	110.2	5.15 (Rs. 5150)
Total profit  5150-2350			Rs 2,800

This trade has brought us a profit of Rs. 2,800 for one lot of Leadmini and Zincmini

This type of trades can be done in currency pairs also giving a modest return.  All what requires is judgment of the direction of the commodity involved. If one is familiar with the movement of price and the price band in which the commodity is, this type of trade can bring safe but sure returns for the margin money involved.

Thanks for your visit.