Spread is a very important term in finance. While there are a few different definitions, they all refer to the difference between two prices, rates, or yields.
One of the most common definitions of spread refers to the gap between the trader’s bid and the ask prices of an asset (a stock, bond, or commodity). It is also usually known as the bid-ask spread.
Another very common definition refers to the difference in a trading position between the selling in currency and the buying price. This spread is usually called spread trade.
In Forex, for example, the spread is the difference between the selling price and the buying price of a pair of currencies.
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Different types of spreads
There are several types of spreads and while they are all similar, there are a few differences that may be relevant to those interested in online trading.
The main reason for having different spreads is that they depend on what are you buying or selling. If you’re trading in stock you will be talking about a bid-ask spread, but if you’re dealing in bonds, the spread compares the yields, which is how much you are going to gain from them.
Bid-Ask Spread
This spread refers to the difference in the price of an asset between buying and selling, usually stocks. Many factors affect this spread. The demand for a stock and the total trading activity has a direct impact on the spread.
Depending on the trading asset, the price may be the difference between the strike price and the market value, as for stocks.
Spread Trade
Spread trades refer to buying one security and selling a related security. This usually happens with future contracts. The overall net trade should have a positive value and is called a spread.
Yield Spread
This spread, also known as a credit spread, sows the difference between the quotes and returned rates comparing two investment vehicles. Therefore, this spread shows the credit quality of those vehicles.
Z-Spread
The Z-Spread is used for securities with a mortgage. It’s also known as the zero volatility spread. The Z-spread is constant and it shows the price of a security equal to its present value in cash value at any point of the Treasury curve.
Option Adjusted Spread
The Option Adjusted Spread represents the discount of a security’s price matching it to the market price. It’s often used for mortgage-backed securities.
Spreads in examples
So, we defined a spread as the difference that exists between two similar measurements. It could be stock prices, yields, or interest rates.
An example of a bid-ask spread may help understand better how it works:
If you’re planning on bidding for stocks, you may bid for 10 dollars a unit. Then you will ask for 10.50 to sell. The spread is the difference between the asking price and the bidding price, therefore 0.50 dollars.
With bonds, the spread will be calculating and comparing yields. Yields are the potential earnings from a certain security, in this case, bonds. In this particular case, the yield spread will look into the US Treasury and give a result in a percentage.
This has been a brief introduction to the complex world of spreads and their relevance at the moment of investing in online trading. Without a doubt, you should research deeper into this topic since it will show you how much you stand to earn, and after all, that is what the market is all about.
