Futures are a risky matter. So much so that even the veteran players are worried about taking a hit (loss) and as a matter of fact, they often do. Paul Tudor Jones, one of the most successful futures traders on the Dow indices, said never to focus on the money that you are making but to focus on the money that you are losing. The money that you have at risk is at the center of any successful trade strategy.
What is a spread order?
Spread order is an order that helps you focus on the money you have at risk and make a strategy to minimise that risk as far as possible. Sometimes, a simple stop loss is not effective as it does not allow the market to have it’s own swings and then come in your favour. Here is what you can do while online share trading futures and options. Place an order, that would make you a profit in case the initial order makes a loss. Which is as simple as saying that you go long on one position and go short on the same position for a different expiry.
Is spread orders a smartest way of hedging a position in stock market trading
It’s not always necessary to deal in the same strike prices except for some particular cases. The online share trading strategy will work just fine even when for the counter order, you choose to take a different scrip, the same expiry, or a different one, trade on the same exchange or even change that but the underlying idea is to acquire a position that will either directly or indirectly make a profit when your original position makes a loss.
How to place a spread order?
Let’s try to understand it better by seeing how we place a spread order and it’s types. There are primarily three types of spread orders, SP or a calendar spread, 2L or a two-legged spread and 3L or a three-legged spread. Let’s try and understand how to place them.
You can open the spread order window by clicking ctrl + shift + F1.
SP Calendar Spread
A calendar spread is an order system using which you can take two positions, one in a contract whose expiry is nearby and another whose expiry is far off. You can choose an SP spread order from the drop-down list at the bottom of the order placement window.
A standard case is to sell NIFTY futures with an expiry nearby and buy NIFTY futures with a far-off expiry in order to create a calendar spread position
This arrangement allows us to dodge the risk. If our short-term predictions fail, a counter effect (of profit) from the far off contract can make us some profits and we will still make money. It is important to note here that the two legs of this order vary only in their expiration date and the underlying instrument, buy/sell time and strike price are all the same.
The usual case is to buy futures or options expiring in a far off month and sell futures or options in a nearby month. Such a strategy is used mostly in cases where the implied volatility on the contract being bought is significantly lower compared to the implied volatility on the contract being sold.
One more functionality of selling the near-month expiry and buying the far month expiry is to carry forward a contract from one month to the other if you feel that you can make more money out of the stock if you hold on to it for a little longer. This is referred to as a roll over position.
A two-legged order is used in cases where you would either want to take a roll over position or benefit from correlated markets. Which means that you either want to move from the futures contract of one month to the futures contract of the next month or want to place a trade to benefit simultaneously from two correlated contracts.
For example, you might want to roll over from a July NIFTY futures contract to an August NIFTY futures contract for which the most straightforward thing to do is to sell your July futures and buy an August contract. But you could be in serious trouble if the market suddenly moves against your interest. You might end up losing a lot of points.
Which is why you would use a 2L spread order that will place both the orders simultaneously. It is also important to note that all of these orders are IOC (Immediate or Cancel) or as some would call it, Fill or Kill, which means that if the order is not executed immediately after its placement, it’ll be cancelled. Such an arrangement is necessary in cases where the whole point of placing an order is to avoid the time lag between selling one contract and buying the other or vice versa.
Another case could be that of two related contracts that you wish to enter into simultaneously to reap combined benefits. This could be the case when you think CNXINFRA is going to drop but are pretty sure that in turn CNXIT is going to go strong. You could place a 2L spread order to Short CNXINFRA and simultaneously buy CNXIT both these orders will execute at the same time.
In the above screenshot you can see the two simultaneous order placing fields. You can choose two completely different scrips here since it’s up to you to create a hedged position the way you would want to. Both the orders can have totally different strike prices, quantities, buy/sell types as well as the lot size. The only mandatory common is that they will both be placed simultaneously and will be IOC orders.
In a stock market, a 3L spread order is a 3 legged spread order where you can place 3 simultaneous orders at the same time. Specific for strategies where you need the simultaneous execution of three orders. A standard example is the butterfly strategy in options trading. A long call butterfly is where you sell 2 at-the-money call options, buy 1 in-the-money call option and buy 1 out-of-the-money call option. This is called a long call butterfly strategy since the payout graph of the strategy resembles a butterfly. Such a strategy is used when the market is showing extremely low volatility. Similarly a short call butterfly is used when the market is extremely volatile. A short call is also placed using a 3L spread order.
The above screenshot shows a 3 legged order where you can choose the three legs that you wish to execute in order to create the position you think will be most beneficial for you. The butterfly strategy mentioned above is one such strategy.
There are several other strategies you can read about that can benefit from three simultaneous orders executed at the same time.
Margin Requirements for Spread Options
The margin required to place a spread order works slightly differently from normal orders. All spread orders are IOC or Immediate or Cancel. Fill or kill is another traditional name for these orders which basically means that if these orders aren’t immediately placed, they will be cancelled.
So while placing a spread order, you will initially need a complete margin but your position is hedged, lowering the risk, which gives you a benefit eventually once the order is placed.
Say for example, if you want to buy 1 lot of NIFTY (at 8480 points) futures for August expiry and hedge it with one lot of NIFTY futures for September expiry, the total margin required would be somewhere around 42,500 Rs. for both the contracts. But in the case of a calendar spread you would only need this margin while placing the order in stock market.
Once the order is executed, due to the hedged position, your risk is lower and so the margin required is only (almost) 4500 Rs. The rest of the money is freed and you can use it for another trade. 2L and 3L orders also have similar cut down on margins when your positions are hedged.
Also Read : Trade Smart Online demystifies the Nifty BeES
In closing, spread orders might be slightly complicated to “construct” but they are very useful in times when the markets are tricky and you want to surgically make profits from derived effects of multiple scrips bought or sold at the same time.
While spread orders allow you to only place a maximum of 3 orders at the same time, you can look at basket orders where you can place more than 3 orders at the same time and create a position.
We hope this blog helped you understand spread orders better. If you still have doubts, please feel free to pin them down in the comments section and we will make sure we get back to each comment and query as soon as practically possible.
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