Calendar Spreads, Outright Futures Positions, and Risk.pdfVIP

WINTER 2002 THE JOURNAL OF ALTERNATIVE INVESTMENTS 59 A futures calendar spread is con- structed by simultaneously buying and selling two futures contracts with a common underlying instru- ment but different expiration dates—for instance, buying a December SP 500 futures contract and selling a September SP 500 con- tract. While spreads are generally considered to be less risky than outright futures positions, it is important to recognize that market par- ticipants typically trade a larger number of spreads than outrights. Presumably, such traders are attempting to achieve greater returns with similar risk, or similar returns with less risk. Depending on the relative sizes of the posi- tions and the performance of the spreads vis-a?-vis the outright, the goal of achieving similar returns or risk may or may not be realized. These considerations raise several issues. For example, do these different trading approaches display similar performance (i.e., high or low correlations)? What are the rela- tive risks of a calendar spread versus a single outright futures position? Are these risk char- acteristics stable over time? Given the relative risks, what are the appropriate capital (margin) requirements for trading spreads versus out- right futures? Similarly, how many spreads should be traded to achieve comparable risk to a single outright futures position? Finally, what is the relative historical return performance of calendar spreads and outright futures positions with comparable risk? We propose one way to determine the “appropriate” number of calendar spreads to trade relative to (or instead of) a single outright is to equalize the values-at-risk (VaR) of the two positions. If we assume that daily price changes in a single outright and a single calendar spread are both normally distributed, then the ratio of their respective standard deviations represents the multiple of spreads that offers a comparable VaR to a single outright, ex ante. We call this mul- tiple the e