Spread Ratios

[lthams]

Good Morning,

I am a relatively new trader learning how to trade spreads and would like to seek advice on calculating the spread ratios for the two legs of the spread. Should I be equalising the dollar notional values of the two legs or should I be looking at the respective ATRs and equalising them / equalising volatility?

Let's say I'm doing a spread between the 6E and the 6A futures contracts.

Methodology 1 (equalise notional dollar value)

6E: 1.2168 X 12.50 = 15.21

6A : 1.0320 X 10 = 10.32

Spread Ratio: 15.21 /10 = 1.52

Methodology 2

6E: 12.50 per tick

6A: 10 per tick

Spread Ratio: 12.50 / 10 = 1.25

Methodology 3: Based on ATR and volatility

6E : 60 period ATR based on 1 day timeframe= 0.0104

So 0.0104 X 12.50 = 1300

6A : 60 period ATR based on 1 day timeframe = 0.0089

So 0.0089 X 10 = 890

Spread ratio: 1300 / 890 = 1.46

I am unsure about which is the correct way to calculate the spread ratio. I would really appreciate advice on this.

 

[kre-]

Please find out carefully what dollar neutral means. Your understanding of it is dubious. Also, taking ATR as a gauge of volatility to calculate your ratio is also mathematically wrong, much better of calculating historical volatility or doing a regression of log returns.

And why reinvent the wheel by taking 6E/6A when there is EAD available on CME? And it is just the simple cross rate of having 6E/6A..

 

[scose-no-doubt]

Please find out carefully what dollar neutral means. Your understanding of it is dubious. Also, taking ATR as a gauge of volatility to calculate your ratio is also mathematically wrong, much better of calculating historical volatility or doing a regression of log returns.

And why reinvent the wheel by taking 6E/6A when there is EAD available on CME? And it is just the simple cross rate of having 6E/6A..

 

[scose-no-doubt]

Spread trading is all about non-linear regression analysis and interpretation of results to form a trade able thesis or have a look at Barjon's thread for a simpler approach along with semi-useful discussion on the risks and the usual armchair criticism of the strats.

Good luck.