Spread is the price difference between the Buy (Ask) and Sell (Bid) rate in Forex. In general terms, spread is the difference between two rates, prices, or yields.
The Bid-Ask spread is also known as the Buy-Sell spread. This is dependent on many factors in the financial world such as:
- Supply or “float”
- Interest or demand in a stock
- Trading activity of the stock
For securities such as stocks, currencies, options, and futures contracts, spread is the difference between the ask and the bid—the on-the-spot order and on-the-spot sell, respectively. For stock options, it is the difference between the market value and the strike value.
The bid-ask spread evaluates the volatility of the market and the transaction cost of the stock.
Spread Trade or relative value trade is the buying of one security and the selling of another related security as a unit. Spread trades are usually done with futures contracts or options. These trades are carried out to get an overall net trade that has a positive value, which is the spread.
A spread is priced as a unit or as pairs in future exchanges to guarantee that the buying and selling of securities is simultaneous. In this way, execution risk is eliminated.
Yield spread or credit spread shows the difference between the quoted rates of return of two investment vehicles. Usually, these vehicles differ when it comes to credit quality.
Some finance analysts define it as the “yield spread of X over Y”. Usually, this is the difference between the yearly percentage return on investment of two financial instruments.
The yield spread is added to a benchmark yield curve to discount a security’s price to match the current market price. The resulting price is called option-adjusted spread. Usually, it is used in bonds, options, and interest rate derivatives.
In securities with cash flows separated from future interest rate movements, the option-adjusted spread is the Z-spread.
The Z-spread, also called as yield curve spread and zero-volatility spread, is used in mortgage-backed securities. It is the result of zero-coupon treasury yield curves which are used in discounting pre-determined cash flow schedule to attain its current market price. Z-spread is also used in credit default swaps (CDS) in measuring credit speed.