The Basics Of Spread Contracts
Posted by | Posted in Trading | Posted on 07-09-2010
Spread contracts have a variable payout that lets you take a short-term position on the direction of a market. Their simple structure allows you to trade on where the price will go, while limiting your exposure to extreme price changes.
Spread contracts are settled on the basis of an underlying market. The underlying markets are generally a Futures market such as grain or precious metals.
As an example, if you buy a Spread contract you are essentially buying a instrument that you are taking apposition ion will be worth more than the buying price at expiry. And conversely, when you sell a Spread contract you are speculating that the underlying market will be lower at the time of settlement.
Floor and Ceiling
All Spreads contracts have top and bottoms called Floors and Ceiling associated with them. These represent the minimum and maximum levels at which the Nadex contract can be settled, no matter how far past either level the underlying market may have moved. These values remain constant during the contracts lifecycle. Because the settlement range of a Spread contract is rigidly defined, the maximum possible loss (or profit) is always known in advance.
Contract Size
The unit of measurement used for spread contracts is 1-point (or 1 tick); any movement in either direction means a $1 loss or profit. For example, if you bought 5 contracts and later sold them for a 35-point gain your profit would be 5 x 35 x $1 = $175. Conversely, if you bought 5 contracts and settled at a 10 point loss, you would lose 5 x 10 x$1 = $50. So whenever you trade a contract, you know that a 1-point movement is worth $1 per contract to you
Please note that the value of a point may vary depending on the underlying market. As an example, Wall Street 30 is quoted in full numbers, i.e. 11467, while Crude Oil is priced in dollars and cents, i.e. $75.09.
Comparison with underlying market
For the Master Spread contract, the large Floor/Ceiling range means that the underlying market will generally be trading between these values. Therefore the price of the Master Spread contract is likely to be easily compared with the underlying market.
Narrow spreads on the other hand have a converse relationship, that is the levels of the floor and Ceiling may be narrow meaning that the underlying market might be trading near (or outside) of those levels. This results in prices that reflect a much higher degree of optionality and are harder to compare with the underlying market.
For more information about Spread Contracts and Forex Trading see IG Markets.
These products are not suitable for everyone, so please ensure that you fully understand the risks involved. These products are volatile instruments that involve a high risk of losing all of your investment. Past performance is not always indicative of future results
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