Spread Option

What Is a Spread Option?

A spread option is a type of option contract that gets its value from the difference, or spread, between the prices of at least two assets. Spread options vary from different option spread strategies developed with various contracts on various strike prices or contrasting lapses. Other than the unique type of underlying asset — the spread — these options act in basically the same manner to some other type of vanilla option.

Grasping Spread Options

Spread options can be written on a wide range of financial products including equities, bonds, and currencies. While certain types of spread options trade on large exchanges, their primary trading scene is over-the-counter (OTC).

The underlying assets in the above models are various commodities. In any case, spread options may likewise cover the differences between prices of a similar commodity trading at two unique locations (location spreads) or of various grades (quality spreads).

A few types of commodity spreads empower the trader to gain exposure to the commodity's production cycle, specifically the difference between the inputs and outputs. The most eminent instances of these processing spreads are the crack, crush, and spark spreads, which measure profits in the oil, soybean, and power markets, separately.

In like manner, the spread can be between prices of a similar commodity, yet at two unique points in time (calendar spreads). A genuine model would be an option on the spread of a March futures contract and a June futures contract with a similar underlying asset.

Note that a spread option is not equivalent to an options spread. The last option is a strategy typically including at least two options on the equivalent, single underlying asset.

Spread Option Examples

In the energy market, the crack spread is the difference between the value of the refined products — warming oil and fuel — and the price of the input — crude oil. At the point when a trader expects that the crack spread will strengthen, they accept that the refining edges will develop in light of the fact that crude oil prices are weak or potentially demand for the refined products is. Rather than buy the refined products and sell crude oil, the trader may essentially buy a call option on the crack spread.

Likewise, a trader accepts that the relationship between close month wheat futures and later-dated wheat futures presently trades essentially over its historical reach. This could be due to abnormalities in the cost of carry, weather examples, or supply as well as demand. The trader can sell the spread, trusting that its value will before long return to normal. Or on the other hand, they can buy a put spread option to achieve a similar goal, yet at a much lower initial cost.

Spread Options Strategies

Keep in mind, spread options, which are specific derivative contracts, are not options spreads, which are strategies utilized in trading options. Nonetheless, on the grounds that spread options act like most other vanilla options, a trader can thus carry out an options spread on spread options — buying and selling various options in light of a similar underlying spread.

All options give the holder the right, however not the obligation, to buy or sell a predetermined underlying asset at a specific price or by a specific date. Here, the underlying is the difference in the price of at least two assets. Other than that, all strategies, from bull call spreads to iron condors, are theoretically conceivable.

The caveat is that the market for these exotic options isn't however robust as it seems to be for vanilla options. The major exemptions would be crack and crush spread options, which trade on the CME group, so the markets there are more dependable. Therefore, these options strategies are all the more promptly accessible.

Features

• Spread options typically trade over-the-counter (OTC).
• The price spread utilized might be the spread among spot and futures prices (the basis), between interest rates, or between currencies, among others.
• A spread option capabilities as a vanilla option however the underlying is a price spread rather than a single price.