Editor's Note: Options are not suitable for all investors. Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Please see the Characteristics and Risks of Standardized Options.
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In finance, the term spread refers to the difference between two related financial metrics: often a stock price or the differential between bond yields.
While its meaning can vary depending on the asset, understanding spreads is crucial for investors aiming to optimize their strategies. For example, the bid-ask spread of a stock — the gap between the highest price a buyer is willing to pay and the lowest price a seller is willing to accept — is a key indicator of liquidity and supply-demand dynamics for that stock.
For bonds, the spread captures differences in yields between bonds of varying maturity lengths or quality. Meanwhile, in more complex areas like options trading, spreads can involve differences in strike prices or expiration dates, helping traders form sophisticated strategies.
Key Points
• A spread is the difference between any two financial metrics, such as a stock price or bond yield.
• The bid-ask spread refers to the gap between a stock’s bid price (the highest price a buyer will pay) and the ask price (the lowest price a seller will accept)
• Several factors can affect a stock’s spread, including supply and demand, liquidity, trading volume, and volatility.
• A tight spread suggests buyers and sellers generally agree on a stock’s value, while a wide spread may signal a lack of consensus on its value.
• Investors may also consider the spread between bond yields, and when using certain options-trading strategies.
What Is Spread in Finance?
A good way to visualize spread may be to think of buying a home. As a home buyer, you may have a set price that you’re willing to pay for a property.
When you find a home and check the listing price, you see that the seller has it priced $10,000 above your budget. In terms of spread, the maximum amount you’re willing to offer for the home represents the bid price, while the seller’s listing price represents the ask.
When talking specifically about a stock spread, it is the difference between the bid and ask price. The bid price is the highest price a buyer will pay to purchase one or more shares of a specific stock. The ask price is the lowest price at which a seller will agree to sell shares of that stock.
A wide bid-ask spread may indicate less liquidity and higher costs for a particular stock; a narrow bid-ask spread may indicate more liquidity and lower transaction fees.
The spread between bond yields can highlight the difference between the yields for bonds of different qualities (e.g., Treasurys vs. corporate bonds) or maturities.
Thus, the spread can have a material impact on trading decisions.
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What Does Spread Mean?
Spread can have a variety of applications and meanings in the financial world, whether for trading stocks or other types of assets.
• Bonds. As mentioned earlier, bond spread typically refers to differences in yield. But if you’re trading futures, the spread can measure the gap between buy and sell positions for a particular commodity.
• Options. With options trading, it can refer to differences in strike prices when placing call or put options.
• Forex. Spread can also be used in foreign currency markets or forex (foreign exchange market) trades to represent the difference between the broker’s selling price for a currency, and the price at which they’re willing to buy the currency.
• Lending. With lending, spread is tied to a difference in interest rates. Specifically, it means the difference between a benchmark rate, such as the prime rate, and the rate that’s actually charged to a borrower. So for example, if you’re getting a mortgage there might be a 2% spread, meaning your rate is 2% higher than the benchmark rate.
Bid-Ask Price and Stocks Spread
Whether you buy stocks online or through a traditional broker, it’s important to understand how the bid-ask price spread works and how it can affect your investment outcomes. Since spread can help investors gauge supply and demand for a particular stock, investors can use that information to make informed decisions about trades and increase the odds of getting the best possible price.
Normally, a stock’s ask price is higher than the bid price. How far apart the ask price and bid price are can give you a sense of how the market views a particular security’s worth.
If the bid price and ask price are fairly close together, that suggests that buyers and sellers are more or less in agreement on what a stock is worth. On the other hand, if there’s a wider spread between the bid and ask price, that might signal that buyers and sellers don’t necessarily agree on a stock’s value.
What Influences Stock Spreads?
There are different factors that can affect a stock’s spread, including:
• Supply and demand. Spread can be impacted by the total number of outstanding shares of a particular stock and the amount of interest investors show in that stock.
• Liquidity. Generally, liquidity is a measure of how easily a stock or any other security can be bought and sold or converted to cash. The more liquid an investment is, the closer the bid and ask price may be, since it can be easier to gauge an asset’s worth.
• Trading volume. Trading volume means how many shares of a stock or security are traded on a given day. As with liquidity, the more trading volume a security has, the closer together the bid and ask price are likely to be.
• Volatility. Measuring volatility is a way of gauging price changes and how rapidly a stock’s price moves up or down. When there are wider swings in a stock’s price, i.e., more volatility, the bid-ask price spread can also be wider.
Why Pay Attention to a Stock’s Spread?
Learning to pay attention to a stock’s spread can be helpful for investors in that they may be able to use what they glean from the spread to make better decisions related to their portfolios.
In other words, when you understand how spread works for stocks, you can use that to invest strategically and manage the potential for risk. This means different things whether you are planning to buy, sell, or hold a stock. If you’re selling stocks, that means getting the best bid price; when you’re buying, it means paying the best ask price.
Essentially, the goal is the same as with any other investing strategy: to buy low and sell high.
Difference Between a Tight Spread and a Wide Spread
A tight spread could be a signal to investors that buyers and sellers are more or less in agreement that a stock is valued correctly. A wide spread, on the other hand, may signal that there isn’t necessarily a consensus on what the stock’s value should be.
Executing Stock Trades Using Spread
If you’re using the bid-ask spread to trade stocks, there are different types of stock orders you might place. Those include:
• Market orders. This is an order to buy or sell a security that’s executed immediately.
• Limit orders. This is an order to buy or sell a security at a certain price or better.
• Stop orders. A stop order, also called a stop-loss order, is an order to buy or sell a security once it hits a certain price. This is called the stop price and once that price is reached, the order is executed.
• Buy stop orders. Buy stop orders are used to execute buy orders only when the market reaches a certain stop price.
• Sell stop orders. A sell stop order is the opposite of a buy stop order. Sell stop orders are executed when the stop price falls below the current market price of a security.
Stop orders can help with limiting losses in your investment portfolio if you’re trading based on bid-ask price spreads. Knowing how to coordinate various types of orders together with stock spreads can help with getting the best possible price as you make trades.
Other Types of Spreads
Apart from the bid-ask spread pertaining to stocks, there are other types of spreads, too.
Options spreads, for instance, involve buying multiple options contracts with the same underlying asset, but different strike prices or expiration dates.
Under the options spread umbrella are several types of spreads as well. Box spreads are one example, and they are a type of arbitrage options trading strategy in which traders use some tricks of the trade to reduce their risk as much as possible.
There’s also the debit spread, which is an options trading strategy in which a trader buys and sells an option at the same time — it’s a high-level strategy, and one that may not be suited to investors who are mostly investing in stocks or bonds.
Note, too, that there is something called a credit spread (similar to a debit spread, but its inverse) and that there are some differences traders will need to learn about before deciding to utilize a credit spread vs. debit spread as a part of their strategy. Again, options trading requires a whole new level of market knowledge and know-how, and may not be for all investors.
The Takeaway
Spread is an important term in finance because it captures the difference between two related metrics for a given security. When it comes to equities, spread is the difference between the bid price and ask price of a given stock. Being able to assess what a spread might mean can help inform individual trading decisions.
As you learn more about stocks, including what is spread and how it works, you can use that knowledge to create a portfolio that reflects your financial needs and goals.
Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).
FAQ
How do you read a stock spread?
A stock spread is the difference between the bid and ask price, calculated by subtracting the bid from the ask price and typically expressed as a percentage.
What influences stock spreads?
Stock spreads are influenced by factors such as supply and demand, liquidity, trading volume, and volatility.
What’s the difference between a tight and wide spread?
A tight spread suggests buyers and sellers generally agree on a stock’s value, while a wide spread may indicate a lack of consensus.
About the author
Rebecca Lake
Rebecca Lake has been a finance writer for nearly a decade, specializing in personal finance, investing, and small business. She is a contributor at Forbes Advisor, SmartAsset, Investopedia, The Balance, MyBankTracker, MoneyRates and CreditCards.com. Read full bio.
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Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
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