Arbitrage in commodities markets
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The explosion of brokerage firms on the Internet leads to an ever increasing competition among them ; one of the ways to have a better offer than the competitors is offering more markets to the trader , broadening his trading horizons from the narrowness of random forex; and since we're talking about MetaTrader, the most easy to automate and yet free platform of this kind, this is done by non-NFA regulated brokers, since NFA forbids the implementation of other contracts as CFDs (futures , stocks and bonds can't be implemented on MetaTrader the way they are). Ultimately, this is what traders wanted from the beginning: a single automated platform usable for trading many markets , in order to deploy logical and profitable strategies, not only indicator-hunting strategies... Perhaps NFA has its reasons for banning CFDs, however, if technical solutions are not found to this problem, US brokers will be effectively wiped out by the competition abroad on the retail segment where MetaTrader is the backbone of traders strategies. There must be a way to solve the fractional trading of futures. Thirty years ago when forex was Zurich centered and trades made by phone minilots and microlots were considered science fiction and these are a reality today. Futures must follow the same path and become sizable for very small accounts... Traders consider NFA no longer to be a "trademark". Exactly how "wireless broadband" grew more important than "Intel inside", the same way "futures inside" has become more important than "NFA-regulated". Think about how much cash the forex retail traders lost just because they couldn't access the contracts they really wanted and were forced to trade markets they didn't understood well... If NFA considers as its duty to protect the traders from fraudulent brokers it should have banned retail forex too : misleading advertising to cover up a casino-like trading environment (no arbitrageable assets). Among the "new" assets introduced by non-NFA regulated brokers (that's the irony of the fate, we must use russian or Middle East brokers to trade american assets) there are the currency futures (I will speak about them in another article), but also commodities. Similar commodities are traded on different markets, so arbitrage opportunities appear. Real and frequent, and not so easy to be manipulated by the broker (as FPI / Intercross Arbitrage with forex , where arbitrage opportunities are so easy to remove as slapping the fingers). Many brokers offer, of course, many have seen this already, Gold and Silver. However, since there are not at least two gold contracts and two silver contracts it's easy to understand these are not arbitrageable.
The single broker supporting the commodities below:
WHC forex (the most extensive datafeed) . Since it's not too regulated, you'd better wait for others to follow them!
A brief look at the commodities contracts possibly to be used for arbitrage:
Oil contracts:
WTI = West Texas Intermediate (InterContinentalExchange) ; download contract specification: WTI Contract Specifications on ICE
CL = Crude Light oil (New York Mercantile EXchange) CL Contract Specifications on NYMEX
BRN = BReNt oil (InterContinentalExchange) ; download contract specification: BRN Contract Specifications on ICE (ICE acquired IPE - International Petroleum Exchange)
QM = miNY Light Sweet Crude Oil (New York Mercantile EXchange) QM Contract Specifications on NYMEX
Natural gas contracts:
NG = Henry Hub Natural Gas Futures (New York Mercantile Exchange) NG Contract Specifications on NYMEX
QG = Natural Gas (New York Mercantile Exchange) QG Contract Specifications on NYMEX
Gold contracts:
ZG = 100 oz Gold Futures (Chicago Board of Trade) ZG Contract Specifications on CBOT
GC = Gold Futures (COMEX) GC Contract Specifications on COMEX (division of NYMEX)
Silver contracts:
ZI = Silver 5000 oz (Chicago Board of Trade) ZI Contract Specifications on CBOT
SI = Silver Futures (COMEX) SI Contract Specifications on COMEX (division of NYMEX)
Wheat contracts:
KW = Kansas Wheat (Kansas City Board of Trade , open outcry)
KE = Kansas Wheat (Kansas City Board of Trade , electronic)
KW Contract Specification on KBOT
Cocoa:
C = Cocoa (Euronext) C Contract Specifications on Euronext
CC = Cocoa (New York Board Of Trade) CC Contract Specifications on NYBOT
I did not make an extensive analysis of this arbitrage, but I looked upon a few assets and strategies:
1. Cocoa
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Most time I'd tried to trade them I got "Trade is disabled". They move in a similar way, however, their values are way different. A statistical arbitrage strategy may be deployed, however, a version of Intercross could be applied, since CC is quoted in USD while C is quoted in GBP.
2. Wheat
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http://img441.imageshack.us/img441/8058/keandkwik6.jpg
The two versions of the Kansas Wheat are very closely correlated, moving almost parallel. However, commissions drain out the arbitrage possibilities.
3. Oil
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The variety of oil contracts make possible a large variety of arbitrage strategies.
3.a. CL to QM
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Almost impossible to work out. It's necessary to trade a volume of QM 20 times more than CL to equal pip value. At this ratio, commissions are so high, that breakthru is somewhere at 70-80 CL pips (cents/barrel) difference...
3.b. BRN to CL
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Brent and Crude Light have different fundamentals behind. On a range of 500 daily bars, BRN / CL fluctuates +/- 500 pips. Statistical arbitrage may be deployed. However, a normal arbitrage strategy aiming to pyramidize positions at each 100 pips difference may, or not, work. It may work if both BRN and CL are implemented as continuous futures, the trader having unlimited time to wait for them to come together (this point is where they are not equal, but BRN quoted 100 pips above CL). Otherwise, arbitrage is impossible. Futures have too close expiries compared to the BRN - CL divergence - convergence cycle. An expiry in loss damages account equity and reduces available funds. Even worse, the positions can't be reconstructed from the place they were before expiry because prices are jumpy (new expiry, new interest to expiry embedded).
Difference in USD trading Short BRN , Long CL one lot each (for pips, divide by 10) courtesy Matt Trigwell
(comprises ~500 daily bars)
http://img178.imageshack.us/img178/2497/oilspreadtradebr7.jpg
3.c. BRN to WTI
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It's almost the same as BRN to CL, as WTI floats very close to CL. Which is very useful in the next arbitrage strategy,
3.d. CL to WTI
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This is the most interesting arbitrage strategy with oil. It is quite fast, the strategy could trade one time a day. Usually WTI and CL are on a close range, however arbitrage opportunities appear pretty often. Both trade with 10 pip spread and 1 pip commission. If you would consider mid prices (between bid and ask), trade them when the difference is about 15 pips between mid prices and close when it's reversed. Results are pretty amazing, however execution errors may criple it a little.
http://img212.imageshack.us/img212/8590/wtitoclarbitrageaq9.jpg
Probably the Gold and Silver contracts hide also other "golden" arbitrage opportunities.
My source proposed for this article is WTI2CLsimpleArbitrageScript (see attachment). Please run it a while and report here problems encountered (the initial version was pyramiding trades, but I removed this because I considered it not necessary).
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