Dec
17
Understanding Derivatives
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The North American Derivatives Exchange offers spread contracts. Like a binary option, a spread contract pays out when the underlying security closes higher or lower than the purchase price. Lower and upper bounds define a spread contract’s range. The current purchase price lies somewhere between these bounds, and the total profit or loss for any transaction is based on the initial purchase price.
Unlike binary options, spreads are not an all-or-nothing wager. Your profit or loss is determined by the difference between the purchase price and the expiration price, up to the maximum profit or loss as defined by the upper and lower bounds of the contract.
For example, let’s take the spread contract Wall Street 30 (Mar) 10400.00 to 10500.00 at 3PM. “Wall Street 30 (Mar)” is the underlying market, 10400.00 is the lower bound, and 10500.00 is the upper bound, and 3PM is the expiration time.
The current Bid and Offer prices for this contract will lie somewhere between 10400 and 10500, depending on the current price of the underlying security, the demand for this contract, and the time remaining until expiration For this contract, bid and offer prices are between 10400 and 10500, all depending on the amount of time remaining till expiration, the demand for this particular contract, and of course the current price of the underlying market. If you buy one lot of this contract at 10450, your maximum profit will be $50, and your maximum loss will be $50.
There are two types of spread contracts offered on Nadex—five narrow spreads and one master spread. The master spread for forex contracts ranges anywhere from 300-750 points. The master spread is subdivided into five smaller, narrow spreads that range from 100-250 points each for Forex contracts.
Nadex’s spread contracts have a clearly defined floor and ceiling price, which limits the total profit and loss . Other characteristics of Nadex spreads are that neither stop losses or leverage are offered on the products.
Due to the larger spreads, it may be necessary to put up a larger premium to trade a spread contract than you would for a binary option. Losses or profits for spread contracts can be larger than binary option contracts of the same size.
Perhaps the major differentiator between spreads and binary options is that spreads don’t expire at their max loss or profit. The total profit or loss per trade is dependent on the difference between the settlement price and the purchase price. On a binary option, if the settlement price is even one point below your purchase price, the contract settles at zero and the full maximum loss is incurred. Whereas for spreads, you only lose the difference between the settlement price and the purchase price, up to the maximum loss.
The main difference between binary options and spreads if that they offer different risk profiles. If you are interested in a wider option of time frames (intraday, daily and weekly) and again, a more consistent risk profile.
These products are not suitable for everyone, so please ensure that you fully understand the risks involved . Past performance is not always indicative of future results