Spread Chart

A bit of theory:

A spread on the market is the difference between the value of two baskets of financial instruments. The synthetic instrument (spread) received in such a manner can be traded the same way as regular financial instrument. The only difference is that when buying a spread, you are actually buying the first basket and selling the second one; when selling a spread, vice versa. The main idea when creating a spread is to build such a financial instrument that will fluctuate around its average levels most of the time. As a result, trading such a financial instrument is easier compared to a regular financial instrument, since you only have to buy and sell a spread on the deviations from those averages.

Main strategies of spread trading:

  • Stock pairs trading.
  • Buying/Selling of futures and other tools with high correlation.
  • Arbitrage.

*Pairs trading is different, because the baskets of instruments, which the spread contains, includes only one instrument each. The simplest strategy of pairs trading is as follows: find the related financial instruments with high correlation, build a spread from them, i.e. take a weighted difference in prices.

What is weighting for? When choosing two instruments, even with high correlation they can differ in price, price step, volatility. Weighting in this case is applied to equalize the baskets by these parameters.

How it works… For example: Such synthetic instruments will have a high return rate on average price. After that, you can trade the composite instrument the same as the regular instruments, trying to buy low and sell high.

*Futures and FOREX spreads are very different – you can find a spread to trade for everyone. Here are the main types:

  • Calendar spreads – based on using the same instrument, but with different expiration dates. For example, spread of May and October corn. In practice, a shorter term difference is often used.
  • Cross-goods spreads, e.g., gold-silver pair, or turning to a crops pair – corn-wheat. There is a vast variety of such goods pairs, and many even have their own names.
  • Cross-market spreads – spreads, comprised of futures for the same base good, but traded on different markets.
  • FOREX spread – buying/selling of the specifically select combinations of currencies.

*Index/portfolio arbitration means a creation of a spread between indices and a basket of instruments, repeating this index. Since the markets have very many different indices, ETFs, and other “combined” instruments, in this area there is a big platform for creativity when changing the compounds of the instruments, their weights, etc.

It is the Spread Chart that allows to realize the following strategies in trading.

To open the following module, use:

І. Spread Chart hot key button.

ІІ. Open menu, Spread Chart tab.

The settings window will open next…

in the following window, the necessary parameters are entered to build a spread graph.

*the following image provides an example of the formula.

Let’s take a look at the settings:

1) In the Formula line – a spread formula is entered, the formula may contain multiplication, division, adding and subtraction signs.

2) In the Spreаd Type line – choose one of three types of settings of a spread:

  • Tick Based, i.e. Last Price for each instrument, that the spread contains
  • Long (Bid Ask Based). To calculate this spread, the Best Ask price of all instruments with positive coefficient and the Best Bid for all negative coefficients are considered.
  • Short (Bid Ask Based). To calculate this spread, the Best Bid price of all instruments with negative coefficients and the Best Ask for all negative coefficients are considered.

3) In the Calculation Method line – choose the calculation method:

  • Simple – The current contract prices are used.
  • By point value. To calculate the value, the current prices of contracts are used, including their costs.

4) In the Tick Size line – setup the tick size:

  • Auto.
  • Custom (when this option is chosen, a window to enter the data will pop up)

After entering all the data in the settings window, press the Apply button. The spread graph will then open:

*The following graph has various settings and functions, which can be used both via the tools panel functions and via the graph context menu.