The word "spread" has several different meanings in investing, and can apply to stocks, bonds, or options. Here's a rundown of the various uses of the term, and how each type of spread can be calculated.
Bid-ask spread
When you check a stock quote, in addition to the last trade price, you'll see two other prices known as the "bid" and the "ask." The bid price represents the highest price someone is currently willing to pay for the stock, while the ask price represents the lowest price someone is willing to sell the stock for.
Simply put, the difference between the two prices is known as the spread.
In general, larger companies whose stocks have high volumes tend to have low spreads – sometimes just a penny or two. On the other hand, stocks of smaller companies with relatively low volume may high much higher spreads.
Yield spread
The word "spread" is also used when talking about debt securities, such as bonds or CDs. The calculation for a yield spread is essentially the same as for a bid-ask spread – simply subtract one yield from the other.
For example, if the market rate for a five-year CD is 5% and the rate for a one-year CD is 2%, the spread is the difference between them, or 3%.
Yield spreads are often expressed in basis points, and a 1% difference in yield is equal to 100 basis points. So, the yield spread between two bonds -- one paying 5% and one paying 4.8% could be stated as either 0.2% or 20 basis points.
Option spreads
When talking about options, "spread" has a different meaning entirely. A spread is a type of options trade that involves purchasing one option and selling another of the same stock. There are a few main types of spreads; vertical spreads involve buying and selling options with different strike prices, calendar spreads (also known as horizontal spreads) involve options with different expiration dates, and diagonal spreads involve both different strike prices and expiration dates.
For example, suppose a certain stock is trading for $50. And, let's say that its $45 call options expiring in a certain month are trading for $6.00 per share, while the $50 call options with the same expiration date are trading for $3.50.
A possible vertical spread might involve buying the $45 calls and selling the $50 calls, at a net cost per share of $2.50. There are three scenarios that could happen. The stock could fall to $45 or less at expiration, and the spread would be worth nothing. The stock could remain at $50 or go higher, and the spread would be worth $5.00 -- the maximum possible profit. Or, the stock could finish somewhere between $45 and $50. This trade would be profitable if the underlying stock's price was $47.50 or higher at the time the options expired.
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FAQs
To calculate the spread in forex, you have to work out the difference between the buy and the sell price in pips. You do this by subtracting the bid price from the ask price. For example, if you're trading GBP/USD at 1.3089/1.3091, the spread is calculated as 1.3091 – 1.3089, which is 0.0002 (2 pips).
How to calculate effective spread? ›
3 Effective spread
For example, if the bid price of a stock is $50 and the ask price is $50.10, the mid-price is $50.05 and the execution price is $50.08, the effective spread is 0.06%. You can calculate the effective spread by subtracting the mid-price from the execution price and dividing by the mid-price.
How do you calculate spread rate? ›
The calculation for a yield spread is essentially the same as for a bid-ask spread – simply subtract one yield from the other. For example, if the market rate for a five-year CD is 5% and the rate for a one-year CD is 2%, the spread is the difference between them, or 3%.
How to calculate stock spread? ›
Example 1: Consider a stock trading at $9.95 / $10. The bid price is $9.95 and the offer price is $10. The bid-ask spread, in this case, is 5 cents. The spread as a percentage is $0.05 / $10 or 0.50%.
How is I spread calculated? ›
The I-spread stands for interpolated spread. It represents the difference between the yield on a bond and the swap rate (the interest rate applicable to the fixed leg in the floating-for-fixed interest rate swap, say, LIBOR). A higher I-spread means that a bond has a higher credit risk.
How to calculate spread in math? ›
The range of a data set is the difference between the smallest and largest values in the data set. To calculate the range, subtract the smallest number from the largest number (Range = Maximum - Minimum).
What is a spread calculator? ›
The rate spread calculator generates the spread between the Annual Percentage Rate (APR) and a survey-based estimate of APRs currently offered on prime mortgage loans of a comparable type utilizing the “Average Prime Offer Rates” fixed table or adjustable table, action taken, amortization type, lock-in date, APR, fixed ...
What are the three ways to measure spread? ›
Measures of spread include the range, quartiles and the interquartile range, variance and standard deviation.
How do you calculate the spread ratio? ›
How do you calculate spread ratio? Spread ratio is calculated by determining the difference between the long and short options. For example, if I buy 2 options and sell 1 in a back-ratio spread, that is a 2:1 ratio spread. If I sell 3 options and buy 2 options, that is a 3:2 front-ratio spread.
How to determine a spread? ›
There are three methods you can use to find the spread in a data set: range, interquartile range, and variance. Range is the difference between the highest and lowest values in a data set. You can find the range by taking the smallest number in the data set and the largest number in the data set and subtracting them.
The z-score is simply (spread)/(standard deviation of spread) and spread is calculated based on the stock pair's price history. The basic method to calculate the spread is using a log of prices of stocks A and B. Spread = log(a) - nlog(b), where 'a' and 'b' are prices of stocks A and B respectively.
Why do we calculate spread? ›
In the realm of finance and investment, the term "spread" holds significant importance. It denotes the disparity between two prices, rates, or yields. Essentially, it's a measure of the gap between the buying and selling price of an asset or the variance in yields of two distinct financial instruments.
What is the formula for price spread? ›
Price spread is defined as the difference between the price paid by the consumers and the net price received by the producer for their equivalent produce/ products. It is expressed as the percentage of consmers' price to producers' price.
How do you calculate value spread? ›
The average market-to-book of a portfolio is calculated as the sum of market values of all stocks divided by the sum of book values of all stocks in the portfolio. And the value spread is measured as the log book-to-market of decile ten minus the log book-to-market of decile one.
How do you calculate spread on a bet? ›
Spread bet size does not depend on the currency pair you trade or even your account currency, so it is pretty straightforward. The formula is: bet size = (money risked / stop-loss amount).
What is the formula for percentage spread? ›
On the other hand, the formula to calculate the bid-ask spread percentage is the difference between the ask price and bid price, divided by the ask price. Since the bid-ask spread percentage is standardized, the metric is more practical for purposes related to comparability.
