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What is a 'Spread'

A spread is the difference between the bid and the ask price of a security or asset. It can also refer to an options position established by purchasing one option and selling another option of the same class but of a different series.

1. The spread for an asset is influenced by a number of factors:

a) Supply or "float" (the total number of shares outstanding that are available to trade) b) Demand or interest in a stock c) Total trading activity of the stock

2. For a stock option, the spread would be the difference between the strike price and the market value.

BREAKING DOWN 'Spread'

In finance, there are 5 ways the term spread is used.

Bid-Ask Spread

The bid-ask spread is also known as the bid-offer spread and buy-sell. Their equivalents use slashes instead of dashes.

For securities like futures contracts, options, currency pairs, and stocks, the bid-offer spread is the difference between the prices given for an immediate order – the ask – and an immediate sale – the bid.

One of the uses of the bid-ask spread is to measure the liquidity of the market and the size of the transaction cost of the stock.

Spread trade

The spread trade is also called the relative value trade. Spread trades are the act of purchasing one security and selling another related security as a unit. Usually, spread trades are done with options or futures contracts. These trades are executed to produce an overall net trade with a positive value called the spread.

Spreads are priced as a unit or as pairs in future exchanges to ensure the simultaneous buying and selling of a security. Doing so eliminates execution risk where in one part of the pair executes but another part fails.

Yield spread

The yield spread is also called the credit spread. The yield spread shows the difference between the quoted rates of return between two different investment vehicles. These vehicles usually differ regarding credit quality.

Some analysts refer to the yield spread as the “yield spread of X over Y”. This is usually the yearly percentage return on investment of one financial instrument minus the annual percentage return on investment of another.

Option-adjusted spread

To discount a security’s price and match it to the current market price, the yield spread must be added to a benchmark yield curve. This adjusted price is called option-adjusted spread. This is usually used for mortgage-backed securities (MBS), bonds, interest rate derivatives, and options.

For securities with cash flows that are separate from future interest rate movements, the option-adjusted spread becomes the same as the Z-spread.

Z-spread

The Z-spread is also called the Z SPRD, yield curve spread, and zero-volatility spread. The Z-spread is used for mortgage-backed securities. It is the spread that results from zero-coupon Treasury yield curves which are needed for discounting pre-determined cash flow schedule to reach its current market price. This kind of spread is also used in credit default swaps (CDS) to measure credit spread.

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