Business, Legal & Accounting Glossary
Spread can mean several different things to investors, depending on the nature of the investment. In the case of stocks or other assets, the spread is the difference between the bid price and the ask price. The size of the spread is affected by the total number of shares trading outstanding, demand for the asset, and total trading volume.
In the case of options, spread refers to the act of purchasing a long call option and a short call option, or a long put option and a short put option; each option is then half of the spread. An option spread usually costs less and with lower risk, but has less profit potential than taking a long position outright.
In the case of commodity futures, spread can be the price difference between delivery months in a given market, or the price difference between different contracts or related contracts in a given market. Spread can refer to two strategies in the case of foreign exchange. In the first foreign exchange spread strategy, investors take a long position in one currency and a short position in another. For example, long the U.S. dollar and short the yen. In the second spread strategy, investors take a long and short position in the same currency, but in different months. For example, long the yen in March, short in April.
For fixed-income securities, spread can mean the difference in yield between securities that have the same quality rating but different maturity dates, or the difference in yield between securities with the same maturity date but different quality ratings.
For stocks and bonds, the Spread is the difference between what sellers are asking and what bidders are willing to pay.
If the bid price for a stock is $10, that is what someone is willing to pay for each share. At the same time, the per-share ask price could be $12. The spread is therefore $2. If you put in a market order to immediately buy 1,000 shares of the stock, you have to pay the ask price. (A market order doesn’t specify a price.) If you put in an order to immediately sell 1,000 shares, you have to take the bid price.
In stock markets, bidders and askers can be paired up by computers or by broker/specialists who are out on the actual floor. These matchmakers profit because of the spread. In the above example, because the orders specify an immediate transaction, the buyer must pay the ask price of $12 each for 1,000 shares, costing $12,000. But the seller has agreed to sell them at the bid price of $10 each, or $10,000. The difference, the spread, in this transaction is $2,000, and it goes to the middleman.
The bid-ask spread is a function of supply and demand. If something other than a market order is placed, there will be price specifications or time specifications that don’t bind investors to the bid/ask prices that exist when the order is placed. This allows more of the give-and-take of trading/compromising/dickering.
Ask price
Bid price
Best ask price
Best bid price
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This glossary post was last updated: 28th November, 2021 | 0 Views.