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hedged position composed of two substantially offsetting positions
--for example, the sale of a contract for a put option together
with the purchase of a contract for a put option--called a "put
spread". Each of the offsetting positions is called a "leg" of the
spread.
In an open position, price changes in the underlying asset
directly affect the value of a futures contract. In the case of a
spread, the holder is both a purchaser and a seller of the same
asset. Accordingly, when there is a change in the market price of
the underlying asset, the price of each leg changes; one leg
appreciates while the other depreciates.
The movements in each leg do not necessarily equal those in
the other, and the price differential between them could change.
A gain or loss will be incurred if the price differential widens or
narrows; there will be no gain or loss if the spread remains
constant. The profit or loss potential of a spread is measured by
the increase or decrease in the price differential between the
legs. Owning a spread involves less risk than owning an open
position because the spread is less volatile than the price of
either leg. Therefore, the profit potential of a spread is less
than that of an open position.
Initial positions in the Merit T-bill option market took the
form of "combination spreads". A combination spread involves
acquiring a put spread and a call spread at the same time. Each
put spread and call spread consists of two options--one bought and
one sold--on the same underlying T-bill. A combination spread
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Last modified: May 25, 2011