costs of such transportation, especially freight rates, in general control the differences in question. These differences are not quite constant, however, and there is under way a continual process of adjustment and readjustment. The general relation of future trading to the unification of markets and to the constitution of what may appropriately, though with some degree of qualification, be called a "world market" for grain, has been previously discussed.12 "Spreading" between markets is the principal means by which the futures markets are made to serve this function of unification.

Spreading is buying or selling futures in one market or option and at the same time selling or buying futures in another market or option. For example, a trader who buys Winnipeg May wheat and sells Chicago May wheat at the same time, or buys Chicago September wheat and sells Chicago May wheat at the same time, is spreading. These spreading operations may be varied in many ways. The purpose is always the same, however, namely, the trader expects to obtain a profit from changes in price differences or spreads between the futures he has bought and sold.

Spreads are made because the operator thinks that the two markets or options are out of line. The trader must decide which of them is thus disturbed or if both are out of line, and in which direction. The expectation of the spreader is that the future he buys is unduly weak and will increase in comparative value, or that the future he sells is unduly strong and will weaken in comparison with the future bought.1

13

There is some so-called spreading between grains. Traders may buy oats futures and sell corn futures, for example, when it is believed that the two are out of line. This operation should not be confused with hedging one grain in another, as described elsewhere. It is of the essence of the situation that the spreader is not concerned as to whether the general trend of prices is up or down. He is concerned with the widening or narrowing of the "spread," or the difference between two prices, and not with an upward or downward tendency that affects both contracts. The form in which a spreading order is expressed is to buy and sell on the respective exchanges at a specified difference in price, for example, " 10 corn at 7 cents difference." A concern may be in position, however, to execute its own trades on the two exchanges involved in an inter-market spread.14 What is above called a spread has sometimes been called a "straddle," and indeed is rather generally so referred to in the cotton trade. The term "spread" refers primarily to the price difference instead of to the attempt to profit by operating with it. But current usage in

12 In Vol. VI, Ch. IV, p. 108, and in Ch. I, of the present volume, p. 18.

18 Some merchants, especially large elevator merchandisers and exporters, shift their hedges from one market to another and from one option to another in a way that may look like spreading. But such shifting of hedges does not affect the character of the trades as hedges, so long as they are set against cash grain commitments in equal quantity. In shifting hedges the controlling consideration will be the comparative weakness (for buying) or strength (for selling) of the various options and markets, as in spreading. Despite the fact that they may be confused with each other by the observer in a particular market, spreading and hedging are different and so appear on the books of the trader. In spreading, future commitments are set against futures and cash commitments are not involved.

"It may not be able to get the spread in as planned, for there is a risk on simultaneous trades "at the market." If the order is given to a commission house, if executed at all, it must be executed according to the conditions accepted. Such execution may involve a debit to the error account of the commission house.

A spread is an operation in futures only, while a he a trade in cash grain with one in futures. If the accou vator company show, for example, not only sold future ing to grain on hand but also a large volume of fu Chicago against which it holds purchased futures in an the company is spreading as well as hedging.

There is also an important difference of business p ever, and this is what is fundamentally significant. 1 T operation is entered upon with a view to profiting b relative prices. On this basis the spread may be said speculative. The ideal hedge assumes that there will in relative prices,16 and the intervention of considerable defeat the purpose of the hedge. For this reason, to sa ing is spreading or, at least, that the hedger is a sprea the cash and the futures is not corect.

There is another kind of spreading on the Chicago ma between job lots and round lots. The profits are, how ently too small, because of the limited scale of the of make this class of dealings of importance.

Section 5. Spreading between markets.

TECHNICAL CONDITIONS AFFECTING PRICE DIFFERENCES the general theory of spreading supposes an equivalence two sorts of futures involved (after allowance has bee freight rates and other charges), nevertheless, spreadi markets and likewise any other form of spreading-is matter of mathematical comparison of actual with supp price differences.

Difference of definition as regards contract grades mu into consideration. Crop conditions at the various cent known. For example, wheat in a particular territory ma injured by rain and rust and yet come within the contra tions. The proportions of the spring and winter wheat a good deal of bearing on spreading between Minneapol cago. Spring wheat raised in the Northwest may be a because of drought, and may also be especially valuable dryness and high gluten content. Grades are not so exa quality of grain likely to be delivered on a future cont disregarded. It is more necessary that a spreader be a n enced in the grain trade than is the case with the specula

THE HANDLING OF SPREAD ORDERS.-As regards the te handling intermarket spreading orders in Chicago it is the outside market end off first, since that is less certain details of execution than the Chicago market.

The order is most frequently given with a limit; t two executions are to be at a specified difference. So specify spreads that will not work. Even when the speci ence appears to be reasonable, sometimes it will not

15 The term for spreading operations between markets in use on the st is "arbitrage." This word is in use at Kansas City and Minneapolis, Chicago.

16 Except for the normal diminution of a carrying charge premium on t 17 Certain results of a statistical study of intermarket price differences to in Ch. IV of Vol. VI of this report.

hedge associat counts of an ele ures correspon futures sold i another marke

purpose, how The spreading by changes to be alwa be no change

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s.-Although e between the en made for ling between

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work, and

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are referred

66

the customer his difference. Few customers will authorize taking a chance, hence it is the broker's loss if he can not execute the second order after having executed the first. He will, therefore, handle an unpaired trade as an error or charge it to his own personal account. Orders for both ends of the spread are said generally to be given to the commission house at the outside (other than Chicago) market, because the outside conditions usually determine whether the spread order can be executed.

SOURCES OF SPREADING TRADE.-Active grain-trade men, including the partners of commission houses, contribute a larger proportion to spreading than to speculative transactions.

The largest intermarket traders are the terminal elevators and exporters. Such trading may be straight spreading or it may take the form of the shifting of hedges, already described in section 8 of Chapter II, preceding. It is said that the bulk of intermarket trading is done by elevators and is mingled with their hedges. Specialist spreaders in futures with no interest in the cash grain used to be a feature of the Chicago board, but they became less important during the war. Some Chicago terminal elevators spread and some do not. At Kansas City several firms specialize in spreading. In general, one end of the spread is at Chicago.

It should be noted that the shifting of hedges may be done from other than directly spreading motives, though where hedges are scattered between markets and where the ratio of open trades to transactions is comparatively low there is a strong presumption that spreading profits are sought.

THE VOLUME OF SPREADING OPERATIONS. The volume of spreading operations can not be definitely determined because spreading orders are largely not distinguishable from other sorts of future trading. It probably has some relation, though not a direct one, to the volume of trading on the smaller markets. It is said that spreads between Minneapolis and Chicago, as measured by open trades, have amounted to as much as seven or eight million bushels at a time. Spreads between Chicago and Winnipeg are often of large volume. There is a considerable but irregular volume of spreading between Chicago and Liverpool futures.

Wheat is most important as regards spreading operations. This is doubtless due to the broader interest in this grain among the various markets. Corn and oats trading are more concentrated. The cessation of trading in wheat futures did away with much of the volume of intermarket trading during the suspension of wheat futures.

FUNCTION OF INTERMARKET SPREADING.-Spreading serves to transmit the influence of world-wide conditions to local prices. In other words, its effect is chiefly to make the smaller markets reflect the world market. The world market as regards grain futures is practically Chicago. Hence spreading may be described as a process tending to keep other futures markets in line with Chicago. But the other markets also react upon Chicago.

At Minneapolis and Kansas City, the futures market, though often supported by spreading to Chicago, is not dependent upon such

may depend upon so-called "changers," who make a prac ing or buying at one-eighth or so above or below the la quotation. There is no proper pit scalping on these mark

Spreading indirectly serves to a greater or less extent simple pit scalping as a means of absorbing large or case of the smaller markets. The scalper in these market that sometimes it works best to protect his trades by sp Chicago, since the volume of trading is not great enoug it easy to get in and out promptly, and perhaps because the do not so directly reflect world-wide conditions and vie does the Chicago market. It is said that hedging pressure apolis, for example, drives the price down, the Minneapolis may buy there and at the same time sell" Chicago," if th difference between the two markets seems to justify it. Section 6. Spreading between options.

GENERAL CHARACTERISTICS.-Spreading between option what different from spreading between markets in respect of commercial judgment required, though the two pro parallel as regards technique. There are paired trans futures for two different delivery months instead of in tw for example, in December wheat and May wheat, both in th market. Such trades on a December-May spread will both before the end of December; otherwise the spread is either another pair of options or converted into straight specula From an economic point of view, spreading between op involve more of a judgment as to the future trend of price the emphasis is still on comparative and not absolute pr. does the process of spreading between markets. The judg to what May will be worth before the close of December ra in May, and what it will be worth, not absolutely, but comp

Spreading operations tend to keep the options in line" other. In other words, sales in an option that is relatively in price tend to bring it back to a position where it shows spread, while the counterbalancing purchases in the oth force it nearer to the first. But not all the regularity of rel tween options need be attributed to the practice of sprea fact the spreaders may sometimes be mistaken in their estir may modify temporarily a price difference that results nomic conditions.

SPREADING BETWEEN OPTIONS RELATING TO THE SAME CROP. the same crop year the controlling factor as regards nor differences between options is the relation of the months maturity to existing and probable stocks of the particular the market in question and the reasonable carrying charge between two options of which one relates to a period of 1 the other to one of small receipts and stocks. The price of wheat option, for example, may be expected normally to b than that of December wheat by something like the cost of the grain in an elevator from December to May.

The difference can not be expected to go appreciably ab cost, because a price difference of the sort indicated offers

Tactice of sell

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supposes, of course, that room can be found to store the grain meanwhile and the funds to finance its holding. Such an operation involving the taking in of grain on one option in the expectation of delivering it out on the next may properly be considered a sort of merchandising,

It is claimed by certain traders in grain that when the far options are at a discount under the near options there is an opportunity for the spreader between options to obtain a fairly regular income without much risk. Price statistics indicate that gains by this means are possible, but it is doubtful if the income would be much more regular than in the case of other speculative ventures. If the futures market tends to be biased in favor of low prices, this tendency means, among other things, that the more remote option is often unduly depressed in comparison with the near-by option.

ELEVATORS AS FACTORS IN INTEROPTION SPREADING.-Spreading between options is largely done by the terminal elevators. In addition to hedging their stocks in the near-by delivery, the elevators may sell large quantities of this delivery and buy corresponding quantities of the next deferred delivery. Elevators holding large stocks of grain hedged in the near-by delivery and in addition having spreads out with the near-by or current delivery sold (and the deferred option bought) may sometimes use deliveries to make a profit on their spreads. If there is a large and scattered long interest they may depress the near futures by preparing to make and in due course actually making heavy deliveries, especially on the first delivery day. This policy will widen the difference between the near and the deferred option and allow the spreads to be closed at a profit, as well as hedges to be shifted forward on a favorable basis.

When the elevator desires to get back the grain which it has delivered it will buy additional current futures and sell the more distant in equivalent quantity and take delivery on the purchases. This will leave it with the equivalent cash grain hedged in a later option. Of course, in such operations the elevator may put the market against itself and be unable to get back the cash grain.

r shifted to ation. ptions may es-though rices-than gment is as ather than paratively. with each y too high s a normal her option lations beding. In mates and from eco-Within mal price of their grain in difference arge and the May e greater carrying

Ove such
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Such practices are apparently important enough to affect the character of the December-May spread in the latter part of November and in December, as is indicated by the seven-year average daily spread curves of Diagram 2.18

It will be noted that, for elevator spreading between options, the profit depends to a considerable extent on the difference between the cash and the futures market. The current or near delivery is depressed by the methods of delivery described above that tend to put it down as compared with the next future. Under such circumstances the spreading profit may be made by buying the cash_and storing and hedging it. This is the most satisfactory hedging situation. Incidentally the similarity of certain kinds of hedging and spreading is confirmed by these illustrative details.

18 Prices are interpolated for Sundays and holidays in order to preserve the continuity of the series. December-May wheat spreads for November 18 and succeeding days to the 30th were: 3.84, 3.80, 3.67, 3.62, 3.70, 3.81, 3.96, 4.52, 4.04, 4.07, 4.10, 4.25, and 4.34, all cents and all plus.

1837-26-8