On page 140 (“Methods of Delivering Alpha”) it says that a bull spread investor in backwardated markets is “hoping for the spread to narrow…” That seems wrong to me. If you’re long the near contract which is higher than the futures which you are short - then the spread would get wider if things went the way you were hoping. And then in the next paragraph is says “In backwardated markets the bear spread investor wants the spread to WIDEN, whereas in contango markets the bear-spread investor wants price differences to WIDEN.” How can it be WIDEN in both cases? Anybody got any ideas? When I pull up errata for Level II from the website - this doesn’t show up so I assume I’m wrong or something… Thank you again so much for the help and Happy Holidays! Regards, Wiggy
I had the same exact issue and was totally confused by it. In normal backwardated market the shorter term futures price will have a higher price than the longer term futures price. So you should sell the shorter term futures contract (for cash equal to X) and buy the longer term futures contract (for cash equal to Y). Therefore profit is X - Y and since X > Y we therefore should hope for the spread to widen. If it were a normal contangoed market then X - Y will be negative and therefore would hope for the spread to narrow to make it less negative. I struggle to understand why the study guide and notes say it the other way around. I wasted so much time trying to understand this and couldn’t find a reason for it being this way. Small things like this and a bad study strategy caused me to give up on the exam. I guess there’s no need to cry over spilled milk and start motivating myself for March 2012.
bull spread widens in backwardted marked
The study guide I believe had an errata on the topic