Spread trade

Infinance, aspread trade(also known as arelative value trade) is the simultaneous purchase of onesecurityand sale of a related security, calledlegs, as a unit. Spread trades are usually executed withoptionsorfutures contractsas the legs, but other securities are sometimes used. They are executed to yield an overall net position whose value, called thespread, depends on the difference between the prices of the legs. Common spreads are priced and traded as a unit onfutures exchangesrather than as individual legs, thus ensuring simultaneous execution and eliminating theexecution riskof 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.
Thevolatilityof the spread is typically much lower than the volatility of the individual legs, since a change in themarket fundamentalsof a commodity will tend to affect both legs similarly. Themarginrequirement 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.
Calendar spreadsare executed with legs differing only in delivery date. They price the market expectation ofsupply and demandat one point in time relative to another point.
A common use of the calendar spread is to "roll over" an expiring position into the future. When afutures contractexpires, its seller is nominally obliged to physically deliver some quantity of the underlyingcommodityto 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.
The contract expiry date is fixed at purchase. If a trader wishes to hold a position in the commodity beyond the expiration date, the contract can be "rolled over" via a spread trade, neutralizing the soon to expire position while simultaneously opening a new position that expires later.
Intercommodity spreads are formed from two distinct but related commodities, reflecting the economic relationship between them.
Common examples are:
Option spreadsare formed with different option contracts on the same underlyingstockorcommodity. There are many different types of named option spreads, each pricing a different abstract aspect of the price of the underlying, leading to complexarbitrageattempts.
Not to be confused withSwap spreads,IRSSpread trades are formed with legs in different currencies but the same or similar maturities.
Two notable examples, U.A.E. Dirham and Saudi Riyal interest rate swaps, are quoted in the inter-bank market as spreads to US dollar interest rate swaps.AEDandSARcurrency exchange rates are each pegged to theUSD, hence their interest rate swap markets are highly correlated to the US interest rate swap market respectively. e.g. if the SAR IRS Spread for a 5-year maturity is quoted as +150 basis points and the USD 5 year IRS fixed rate is trading at 1.00%, where the IRS fixed payments are annual and the floating payments are quarterly LIBOR, then the SAR 5 year IRS fixed rate will be 2.50%.