In the stock market, spread refers to the difference between two prices, typically:
- Bid-Ask Spread: The difference between the highest price a buyer is willing to pay (bid) and the lowest price a seller is willing to accept (ask).
- Spread Trading (Options & Futures): A strategy where traders take opposing positions in related contracts to hedge risk.
Types of Spread in the Stock Market
1. Bid-Ask Spread
- Formula: Spread=Ask Price−Bid Price\text{Spread} = \text{Ask Price} – \text{Bid Price}Spread=Ask Price−Bid Price
- Example: If a stock’s bid price is $49.50 and the ask price is $50.00, the spread is $0.50.
- Factors Affecting Bid-Ask Spread:
- Liquidity: Highly liquid stocks (e.g., Apple, Amazon) have smaller spreads.
- Volatility: High volatility increases spreads.
- Market Hours: Spreads widen in after-hours trading.
2. Spread in Options & Futures Trading
Traders use spread strategies to limit risk and profit from price differences. Examples:
- Bull Call Spread: Buying a call at a lower strike price and selling at a higher strike.
- Bear Put Spread: Buying a put at a higher strike and selling at a lower one.
- Calendar Spread: Buying and selling options of the same stock but with different expiration dates.
Why is Spread Important?
- A narrow spread indicates high liquidity and low transaction costs.
- A wide spread means lower liquidity and higher costs for traders.
- Spread-based strategies help traders hedge risk while managing profits.