Spread Orders: The Smart Way of Hedging Positions

By September 2, 2015 Trading 19 Comments
Spread Orders: The Smart Way of Hedging Positions

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.

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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.

How to place a spread order

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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.

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2L Order


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.

SPREAD order NEST trading 2 legged order

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.

3L Order


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.

3 Legged SPREAD ORDER NEST

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

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Conclusion

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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19 Comments

  • Angel says:

    thanks for this article. Very informative. I always wanted to know about Spread Orders and to maximum exten it helped me in understanding Spread orders. Have just one query. While placing orders, they need to placed simultaneously and order type is immediate or cancelled. So If someone wants to square off the spread order,s ame procedure applies or one can hold on to one position and cut the other. And also effects on margin requirements if one doesn’t have to cut both positions simultaneously.

    • Parth says:

      Hi Angel!

      Thank you for your comment. Yes, you can hold on to one position and square off the other. Spread orders may be called orders but they essentially are a strategy formed by combining multiple orders. Hence after the position is created, you can square off any position that you choose to.
      There is just one small catch. It has to do with the margin money required to do so. When you create a hedged position, the margin requirement is often lower than the margin needed for the individual orders and so if you have all of your margin blocked in other securities, it is possible that you might run into a margin shortage.
      We intimate all clients who are under a margin shortage so they can refill their trading account and avoid heavy penalties that come as a consequence of long held open positions with a margin shortfall.
      I hope this solved your query.

  • smartfuturestrading says:

    Nice article! I would like to add some more advantages of trading spreads:

    1. Spread has tendency to behave based on seasonality patterns. If seasonality is included in the strategy, then there is high probability of successful trades.

    2. Low time needed for preparation and execution of trades – in fact it is a position trading.

    3. Spreads are usually less volatile than his legs.

    Waldemar

    • Rajesh Kumar Samal says:

      Is it possible to create spread in same expiry with same stock i.e buy one lot nifty of Sep 2016 and sell one lot nifty of sep 2016 same time same account

      • Trade Smart Online says:

        Hello Rajesh Kumar Samal,
        You cannot buy and sell same contract at same time. By doing this, your position will get squared off. You are required to change the expiry to create spread. Ex: Buy 1 lot of Nifty Sep 2016 and sell the same with Oct 2016 expiry.

  • krishna patil says:

    give one or two examples of sp.2L,3L by filling order window. current date.1) i want to carry tatasteel from january to february 18 then how i enter my order form?

  • krishna patil says:

    please give examples, filling carious shares, sbin, & bank of baroda. etc.

    • Trade Smart Online says:

      Hi Krishna,
      We request you to elaborate your question to be more clear. Alternatively, you may call us at 022-61208000, our team will help you on your query.

  • Pankaj says:

    Hi,
    Want to know about maximum loss about future spread. Last week i saw future spread value changes from 12 to 383 on Friday. Can the spread value be negative. In that case i can have hugh loss .can i use SL -M for spread or cover order

    • Trade Smart Online says:

      Hello Pankaj,
      Kindly let us know the particular contract in which you saw a high moment. Ideally the difference in value would be less and not as mentioned by you. However, it would again depend on the contract that you are referring to. The spread value can be negative. SL-M and cover orders are not applicable to spread orders. In case you want to place stop loss then you may place a separate SL order which will be an independent order.

  • Pankaj says:

    If negative i have to play more i invested.i am refering may 31st to 28th june nifty future.thanks for your help to understand the risk

    • Trade Smart Online says:

      Hi Pankaj,
      As per our observation we found no such huge movement in the said contract. Kindly call us at 022-61208000 on the day when you observed such moments in any of the contracts so that we can check and let you know.

  • Karthik M says:

    Is spread available on sine mobile app

    • Trade Smart Online says:

      Hi Karthik,
      Currently spread order option is not available in Sine mobile app. However, we will look into this option. Thanks for your comment.

  • Pankaj says:

    Can we have spread order through mobile app

  • Pankaj says:

    Thanks.atleast you have a web version.pls accommodate in mobile app also.you are ahead

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