The successful functioning of global stock index futures markets depends heavily upon the efficient execution of two essential recurring transactions: calendar spreads and stock index arbitrage. At this point in the development of China’s new CSI 300 futures market index, arbitrage is highly inefficient at best, and often impossible. Because calendar spreads are not yet recognized as a legitimate order type for China futures brokers to accept, investors seeking position changes between calendar months are not assured of fair pricing. Using recent CSI 300 futures data, this article seeks to address the central characteristics of calendar spreads and the important uses for this transaction type in China’s newest futures market.
Two important groups of futures market participants are likely to employ calendar spreads either to implement strategies having an investment horizon longer than that of the near-term contract or to capture short-term profits as prices move. The first class of participants would typically include hedgers such as qualified foreign institutional investors (QFIIs) and qualified domestic institutional investors (QDIIs), independent money managers, arbitrageurs, pension funds and mutual funds. The second class of participants is representative of speculators and includes individuals, hedge funds and traders. The different ways in which these two groups use calendar spreads is explored in more depth later in the article.
Establishing the legitimacy of this type of order in CSI 300 futures along with suitable margin controls is essential to ensuring the willingness both of domestic and foreign investors to seek participation in China’s important growing capital market.
Origins And Classification Of Calendar Spread Orders
Calendar spread orders in global futures markets originate from investor requests to execute the simultaneous purchase of a futures contract expiring in one month and the sale of a second contract expiring in a different calendar month with the two orders to be filled at a specified price difference (spread) between the contracts. They are primarily a natural outcome of trading and investing strategies whose completion does not end on a standardized contract expiration date. Such transactions arise as a consequence of the finite lifetimes for futures contracts, a property that periodically forces long-term as well as short-term investors to exchange contracts with differing expiration dates.
In mature global futures markets where there is a balance of institutional, retail and arbitrage participants, there will often occur periods of time when the volume of market transactions is dominated by calendar spread orders from such market participants. As frequent and familiar as calendar spread orders are, there is surprisingly little written about these essential futures transactions. For China’s CSI 300 futures, there is no literature at all. For foreign investors in China’s stock market, understanding more about calendar spreads in these new contracts becomes important not only for institutional firms seeking to hedge but also for hedge funds seeking short-term profits. Assessing the risk of calendar spreads relative to outright futures positions is also important for regulators and exchanges that must set appropriate margin levels if such orders are to be officially recognized.
Calendar spread orders can be transacted intramarket (within the same market) or intermarket (between markets). The analysis in this paper deals strictly with intramarket transactions. Intramarket spreads have the same commodity or asset underlying each contract, while intermarket spreads involve two different commodities or assets. Such spreads, whether intramarket or intermarket, originate both from hedgers and speculators and can require several different combinations of opening and closing transactions (see Figure 1).