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The Basics Of Spread Contracts
By John | September 5, 2010
Spread contracts have a variable payout that lets you take a short-term position on the direction of a market. These contracts are very easy to understand as they allow you to trade on where a price will go thereby limiting your exposure to volatility in the market.
These spread contrast are based on an underlying market and are settled based on that. 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 when you sell a Spread Contract you are doing the inverse: you have speculated that the instrument that you are selling will be lower at the time of settlement.
Floor and Ceiling
Every Spread contract has both a Floor and a Ceiling associated with it. 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. Likewise, if you bought 10 contracts which were settled at a 19-point loss, you would lose 10 x 19 x $1 = $190. This allows you to know that a one point movement is always s worth $1 per each contract you own
The definition of a ‘point’ can vary between different underlying markets. For example, Crude Oil is priced in dollars and cents, i.e. $71.58, whereas the Wall Street 30 is quoted as a whole number, i.e. 10625.
Comparison with underlying market
For what is known as a Master Spread contract a large range between the levels of Floor and Ceiling will generally be trading between these values. So the price of a Maser Spread can be that of the underlying market.
In the case of Narrow Spreads, the closeness of the Floor and Ceiling levels means that the underlying market might be trading near (or outside) these 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
Topics: Trading |
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