Modeling Execution Costs for Exchange-Traded Futures Spreads
Summary
This exchange considers how to represent transaction costs when a futures calendar spread can be traded as a single exchange-listed contract. The question observes that the spread contract may have a lower execution cost than trading its outright legs separately, and asks how that difference could enter portfolio optimization. It gives an example in crude oil and refers to a volume-based transaction cost model as a possible starting point.
The response highlights a key modeling constraint: two combinations that look like alternative ways to express leg quantities may produce different net exposures and therefore different risks. It distinguishes portfolio choice from execution choice. To compare execution methods fairly, first hold the desired exposure fixed, then evaluate ways of implementing it, such as using spreads together with residual outright contracts. The exchange offers conceptual guidance rather than a formal cost function or optimization procedure. It does not provide empirical cost estimates, calibration steps, or evidence that one execution mix is generally optimal.
Key ideas
- Exchange-listed calendar spreads can have different transaction costs from trading their outright legs separately.
- Execution alternatives must be compared at the same target exposure.
- A spread position combined with outright contracts can retain residual exposure in one leg.
- Lower execution cost alone does not establish that a portfolio is preferable, because risk can differ.
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Full text
# Smart transaction cost model (for spread contracts) # Smart transaction cost model (for spread contracts) In futures there exist exchange traded calendar spread contracts, which trade as a single unit (think May/June Crude Oil). The bid ask spread for the spread contracts is the same as that of the outrights, which typically makes trading the spread contract (if you would like to trade a spread) cheaper than trading the outright contracts individually. Is there a way to take this into account in a portfolio optimization problem. For example, perhaps without transaction costs my mean variance optimization says to buy 55 June (M) crude oil contracts and Sell 45 July (N) crude oil contracts. This amounts to buying 55 spread (M/N) contracts and buying 10 July (N) contracts. However, because trading the M/N spread contracts are 50% cheaper than trading the outright contracts, the optimal solution knowing the transaction cost difference may be just to buy 50 M/N spread contracts. Is there a way to formalize this? I know the case in which you have individual assets people typically use the 3/2, volume based transaction model by Chriss. But in cases in which these spread contracts exist is there a formal way of modelling the transaction costs? ## Answer by Hui (score 2, accepted) https://quant.stackexchange.com/a/39961 I think the assumption you made is incorrect. Buying 55 spreads + buy 10 July is totally different scenario comparing buying 50 spreads from the risk perspective as you are net long 10 June contracts in the former strategies. I guess what you are thinking is what is most cost-effective execution strategy for a given trading strategy. That will be an apple-to-apple comparison. For the case you used, what is the best execution strategy? Should be (buy 55spreads + buy 10 July), (buy 45spreads + buy 10 June), or other ways? There are always tradeoffs. Buy 55 June, sell 45 july will be more costly, but the execution efficiency will be higher.
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