Spread Forex

A spread in Forex trading is the difference between the bid and ask price of one currency quoted in another currency. There are also spreads used in options trading that can be applied to trading foreign currencies. In analyzing a currency pair and its spread Forex traders will often choose to trade where the spread is lowest. This reduces the overhead of trading foreign currency pairs. Regarding options trading spread Forex traders develop strategies in order to profit from various market conditions. In quoting a spread Forex quotes the counter currency in terms of the base currency. That is, if the spread is quoted in US dollars then the dollar is the base currency. If the quote is of the Euro in terms of dollars then the Euro is the counter currency.

In a bull spread Forex options traders buy puts or calls in expectation of a rise in price of the counter currency versus the base currency. For example when the USA is keeping interest rates low in an attempt to stem inflation the dollar may fall in relation to the Euro if the EU raises interest rates. Traders who expect the Euro to go up in price in relation to the dollar in this scenario will buy the lower strike price and sell the higher strike price in options with the same expiration date. In a bear spread Forex options traders buy puts and calls in expectation of a fall in the price of the counter currency in relation to the base currency. In the hypothetical example of the US dollar and Euro noted above the trader expects the dollar to go down. Again he buys and sells options but on the dollar with the Euro with the same expiration date, buying at the lower price and selling at the upper. In a butterfly spread Forex traders combine bull and bear spreads with the purchase of three options contracts. The trader uses the lower two strike prices for the bull spread and adds the highest price for the bear spread.

Another spread Forex options traders use is a debit spread. The Forex options trader buys and sells options on the same counter currency with the same base currency. He buys a higher priced option and sells a lower priced option. In doing so he reduces his cost of buying the first option. However, he still pays money or incurs a debt in this situation. The bigger the spread between the two options the higher the “debit” in this trading situation. In a debit spread Forex traders expect the counter currency to rise in price making the whole transaction profitable. To have a firm grasp of how to analyze a spread Forex traders will need experience trading in various currencies with different spreads. In a very volatile market the trader can make money with even large spreads if he correctly anticipates market direction. In a so called “sideway trading” market the spread becomes much more important as the size of the spread may approach the profit potential for the trading of the day.