Meaning And Types of Spread Trading

As technology has advanced and disposable incomes increased, so has the trading approach.

Once upon a time, one could use a simple trading strategy: buy stock from a well-established company, usually from the mining, steel and banking industries, and hold it for many years until its value skyrockets. Many still do.

With the rise of tech companies and the trade sphere shifting more towards the online sphere the number of reliable companies has decreased. These companies are also seeing themselves as being out of date with technology advancements (fuel and coal no longer have the same value now that there are other energy sources).

To adapt to a more complex market, traders have developed a variety of trading strategies. Spread trading is one such strategy. This article will explain what a Spread Trade is and how it works.

Spread trade: What does it mean?

Spread trades are a combination of several trades taken by an investor. One involves buying a future or option. The second involves selling off another future or option simultaneously. The two securities that make up a spread trade are often called 'legs'. They provide the price change required by the investor to turn a profit.

Spread trading is also known as "relative value trading" and traders who use it are primarily looking to make profits when the spread narrows or broadens.

Spread trading strategies: Types

Spread trading can be considered a strategy, but traders can use a variety of strategies depending on the security they want to trade. Let's take a look at some spread trade strategies.

Spread between commodities

Spread trading is a strategy that allows traders to spread trade two commodities, which may seem like they differ on many fronts. The trader will pick the securities if there is a relationship between them. A similar concept may also exist when companies grow upwards or downwards. However, in this instance it is used from the traders' side.

One example is the relationship between a potato farmer and a french fry manufacturer. While the industries in which these commodities are produced vary, such as french fries manufacturers engaging in more consumer-centric functions in secondary and tertiary sector, while potato cultivation is more primary sector focused, there is a direct relationship between them. The price of potatoes could increase and decrease the demand for french fries. A trader could also choose a potato manufacturer and a fast-food outlet that offers price. This would create a similar relationship.

Spread the option

The trader picks two different options and calls them 'legs'. Although the options may vary, the strategy requires that both options be linked to the same security in spread trade. This means that the two options must have some connection.

Spread trading has many benefits

Spread trading is based on an investor choosing two commodities to trade. Hedging these two trades against one another will help reduce risk. Expert traders will seek to hedge to reduce volatility and still retain their assets. Spread trading is a great way to define your risk and then act accordingly.

Conclusion

Spread trading is a popular choice for investors. This allows them to hedge their risk against other security options and define their risk. Investors can also use spread trading to reduce their risk. Spread trading allows investors to capitalize on the differences in the prices of futures and options. It is important to do thorough research on the spread trade options and the futures that are used. One must choose two securities that have an intrinsic link.