Spread Trading?
Q: What was spread trading? I know it was when there was big difference from bid and ask, but how could you trade it?
A:
What you "know" totally differs from what I've learned in the more than
39 years that I have been trading stocks and commodities. A "spread" is
the difference in price between two different instruments, e.g. between
the WU1 and WZ1 (Sep and Dec Wheat futures at the Chicago Board of Trade),
also e.g. between the "deal terms" in GE shares wh
offer to take over HON and the price at which HON itself was trading
(before being blown out of the water by the AntiTrust guys blocking the
proposed merger). The way in which one trades spreads is to buy one of
the instruments and short the other as close to simultaneously as one's
broker can manage so as to lock in a particular difference. In some
commodity futures pits, the spreads themselves are tradeable with locals
or commercials who, in essence, make a market in the spread between
contracts. At a later date/time when the difference between the two
instruments has narrowed or broadened, one unwinds the spread position
by selling the instrument bought earlier and buying in the instrument
shorted earlier.
In some instances, regularly played by arbitrageurs, having bought
the acquiree and shorted the acquiror at a favorable difference, they
need only exchange their acquiree shares for the deal specified acquiror
shares and deliver the resulting acquiror shares against their prior
short to close out their trade.
You are quite correct that the difference between the bid and the ask
on any ONE instrument is also called a "spread", but that isn't a thing
that one "trades" as such. In THAT kind of a spread, you can join the
guys at the bid to buy, you can join the guys at the ask to sell, you can
bid or ask anywhere in between or anywhere outside, but trading that kind
of spread, per se, isn't do-able. The closest thing to trading that spread
is to be a market-maker or specialist on both live sides of the bid/ask.
Have fun with it if you decide to try spread trading. It is a bit of
a challenge because instead of having to understand what ONE instrument
is about, you have to understand two of them simultaneously and in relation
to each other.
To be brief, it's buying on one market, while selling a similar
instrument in another market when there exists a difference in price.
This would include taking a long position in one month of a particular
commodity futures market, while at the same time establishing a short
position in another month.
Probably the most "popular" spread is what is commonly called "buy and
sell" programs in which a trader (usually a brokerage firm) will buy or
sell a contract in the S&P futures market in Chicago while at the same
time taking an opposite position, by buying or selling a "basket" of
stocks in New York that make up an S&P futures contract.
When prices move as to put you in a profitable position, you "unwind"
the spread by taking the opposite action that was taken when the
spread was established.
A common term for this type of trading is arbitrage.