Spread trade

Extracted Attributes

• Components

  Two related securities known as "legs"

• Profit Driver

  The widening or narrowing of the price difference between the legs

• Risk Management

  Provides protection against systemic "black swan" market risks

• Alternative Name

  Relative value trade

• Trading Mechanism

  Executed as a single unit on futures exchanges to eliminate execution risk

• Margin Requirement

  Typically lower than the sum of individual margin requirements due to lower volatility

• Primary Instruments

  Options and Futures contracts

• Common Type: Frac Spread

  A 3:1 or 5:2 propane-to-natural gas futures position

• Common Type: Calendar Spread

  Involves the same financial instrument expiring in different months

Timeline

• In Episode 150 of the All-In Podcast, hosts discuss Morgan Stanley's use of a spread trade to navigate the GLP-1 agonist hype cycle, specifically shorting healthcare incumbents while going long on pharmaceutical innovators. (Source: Document 0d1b8bf2-4839-4e94-af1e-1c882a1d8877)

  2023-10-20

Spread trade

In finance, a spread trade (also known as a relative value trade) is the simultaneous purchase of one security and sale of a related security, called legs, as a unit. Spread trades are usually executed with options or futures contracts as the legs, but other securities are sometimes used. They are executed to yield an overall net position whose value, called the spread, depends on the difference between the prices of the legs. Common spreads are priced and traded as a unit on futures exchanges rather than as individual legs, thus ensuring simultaneous execution and eliminating the execution risk of one leg executing but the other failing. Spread trades are executed to attempt to profit from the widening or narrowing of the spread, rather than from movement in the prices of the legs directly. Spreads are either "bought" or "sold" depending on whether the trade will profit from the widening or narrowing of the spread.

Web Search Results

• Spread trade - Wikipedia

  Further information: Round turn "Round turn (finance)") In finance, a spread trade (also known as a relative value trade) is the simultaneous purchase of one security "Security (finance)") and sale of a related security, called legs, as a unit. Spread trades are usually executed with options "Option (finance)") or futures contracts as the legs, but other securities are sometimes used. They are executed to yield an overall net position whose value, called the spread, depends on the difference between the prices of the legs. Common spreads are priced and traded as a unit on futures exchanges rather than as individual legs, thus ensuring simultaneous execution and eliminating the execution risk of one leg executing but the other failing. [...] A common use of the calendar spread is to "roll over" an expiring position into the future. When a futures contract expires, its seller is nominally obliged to physically deliver some quantity of the underlying commodity to the purchaser. In practice, this is almost never done; it is far more convenient for both buyers and sellers to settle the trade financially rather than arrange for physical delivery. This is most commonly done by entering into an offsetting position in the market. For example, someone who has sold a futures contract can effectively cancel the position out by purchasing an identical futures contract, and vice versa. [...] Spread trades are executed to attempt to profit from the widening or narrowing of the spread, rather than from movement in the prices of the legs directly. Spreads are either "bought" or "sold" depending on whether the trade will profit from the widening or narrowing of the spread. ## Margin [edit] The volatility "Volatility (finance)") of the spread is typically much lower than the volatility of the individual legs, since a change in the market fundamentals") of a commodity will tend to affect both legs similarly. The margin "Margin (finance)") requirement for a futures spread trade is therefore usually less than the sum of the margin requirements for the two individual futures contracts, and sometimes even less than the requirement for one contract. ## Types of spread trades

• spread trading

  QuantPedia # Spread trading Spread trading represents buying one financial instrument and selling the same one or other related financial instrument as a unit. The net position of these transactions is the difference between the sell price of the bought instrument and the buy price of the sold instrument, also called the spread. Spread trading is mostly realized with commodity futures or options contract which can be used in many variations. These variations include for example spread on the same financial instruments (futures or options) which are expiring in different months, spread on related financial instruments with the same maturity or spread on related financial instruments bought/sold on different exchanges. [...] Spread trading represents buying one financial instrument and selling the same one or other related financial instrument as a unit. The net position of these transactions is the difference between the sell price of the bought instrument and the buy price of the sold instrument, also called the spread. Spread trading is mostly realized with commodity futures or options contract which can be used in many variations. These variations include for example spread on the same financial instruments (futures or options) which are expiring in different months, spread on related financial instruments with the same maturity or spread on related financial instruments bought/sold on different exchanges. [...] Another example of a spread trading strategy can be, for example, based on the spread between Natural gas and Propane, which is called “Frac spread” and is created by a 3:1 or 5:2 propane-to-natural gas futures positions. The economic theory says that the relative mispricing between Natural gas and Propane could exist for relatively short horizons. But extended mispricing will likely force producers and processors to cut production of natural gas, and hence the supply of Propane until output revenue and input price reach a long-run equilibrium relationship.

• A Guide to Spread Trading Futures

  ## Reasons to Spread Trade Spread trading futures offers several powerful benefits. First, futures spreads are more balanced than a single contract, which means they limit risk and provide additional routes to profitability, rather than merely betting an asset will move in a single direction. Crucially, this strategy provides robust protection against market-wide risk, which is often impossible for traders to anticipate. If a “black swan” event occurs that creates systemic market risk, futures spreads offer protection relative to a long position. [...] ## Risks to Keep in Mind for Futures Spread Trading Many of the risks associated with spread trading futures are the same risks that are attached to any trading activity. Traders should avoid going too deep on margin or trading positions that are too large for them to comfortably absorb losses. It’s important that traders have the discipline to manage personal trading risk, especially early on. Even though spreads are theoretically safer than taking a long or short position in isolation, if the market moves against you and your trades are excessively large, you can lose substantial capital. [...] Next, margin requirements are lower, which can generate much higher returns on a winning position. Spreads are also less susceptible to the actions of market makers or market movers, allowing traders to make a purer play on an underlying trend. Finally, price movements are easier to predict when futures spread trading, as you can expand your timeline, and are not captive to the more volatile movement of a shorter-dated contract. ## Risks to Keep in Mind for Futures Spread Trading

• What is a Spread — How Does it Influence Trading? - Trade Nation

  If there are many market participants for the specific asset who also agree on the buy and sell price, the trading volume will be high, which translates to a tighter spread. Consequently, if there aren’t many market participants who also don’t entirely agree on the buy and sell price, the trading volume will be lower, which means the spread will be wider. Trading volume is just one of the factors which could influence the spread; we’ll take a look at some additional factors in the next section. Different financial markets and instruments also have different spreads; for example, major forex pairs, such as EUR/USD or GBP/USD, have tighter spreads compared to exotic forex pairs, such as USD/ZAR. [...] ## Key takeaways ## What is the bid-ask spread? In derivative trading, such as CFD trading, the spread plays a key role as it is the difference between an asset’s ask (buy) and bid (sell) prices. The ask (buy) price will always be higher than the bid (sell) price. This is common whether you’re trading forex, indices, commodities, or stocks. It’s also known as the bid-ask spread. The spread can be either tight or wide. One way to define it is based on an asset’s trading volume and liquidity levels. [...] For example, a forex pair such as EUR/USD will have a different spread from a commodity such as gold. However, the actual spread of these two financial assets will stay the same regardless of price changes. This happens when you trade through a broker that uses a ‘dealing desk’ model, meaning they purchase large positions from liquidity providers in order to offer those positions to traders in smaller sizes. This could be beneficial as capital requirements are usually smaller, and a trader always knows the transaction costs. On the other hand, traders who choose to trade fixed spreads could experience some drawbacks, such as requotes or slippage.

• Spreads in Finance: The Multiple Meanings in Trading Explained

  ## The Bottom Line In finance, a spread refers to the difference or gap between two prices, rates, or yields. A common one is the bid-ask spread, which is the gap between the bid (from buyers) and the ask (from sellers) prices of a security, currency, or other asset. A spread can also refer to the difference in a trading position, such as the gap between a short position (selling) in one futures contract or currency and a long position (buying) in another, known as a spread trade. [...] Major currency pairs like EUR/USD typically have tighter spreads because of high liquidity, while exotic pairs may have wider spreads. For traders, especially those engaged in short-term strategies like day trading or scalping, the spread is a crucial consideration as it directly affects the profitability of each trade. Wider spreads mean a trade needs to move further in the trader's favor just to break even. Some brokers offer fixed spreads, while others provide variable spreads that fluctuate with market conditions. ## How Do I Calculate a Spread in Finance? Most basically, a spread is calculated as the difference in two prices. A bid-ask spread is computed as the offer price less the bid price. An options spread is priced as the price of one option less the other, and so on.