Definitions

Spread_trade

Spread trade

In finance, a spread trade refers to the act of buying one security or futures contract and selling another related one, in an attempt to profit from the change in the price difference between the two.

As expiry of a long contract and delivery of the underlying physical commodity approaches, spread trades are used by Index Speculators in commodity futures markets to "roll" their positions out to a later delivery month. Thus, "extinguishing" their open interest in the expiry month while creating new open interest in the later delivery month. Because they always defer delivery, Index Speculators never take possession of physical inventories and do not operate in the commodity markets with concern for supply and demand- only price movement.

Common examples are:

  • Crack spread, between crude oil and gasoline
  • Spark spread, between natural gas and electricity (for gas-fired power stations)
  • Option spread, between the price of two option contracts on the same underlying stock or commodity
  • Calendar spread, between the price of an option or commodity with different expiration/delivery dates.

The margin requirement for a futures spread trade is usually less than the sum of the margin requirements for the two individual futures contracts. Sometimes the margin requirement is even less than the requirement for one of the contracts.

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