Understand What Spread Trading Is: Arbitrage Strategy with Atomic Execution

Spread trading is a sophisticated strategy that involves the simultaneous buying and selling of two different financial instruments to capture price differences between them. This type of operation allows traders to take advantage of arbitrage opportunities with protection against directional risk, creating a balanced approach to optimize potential returns.

In practice, spread trading combines two opposite positions in equal quantities, typically involving pairs such as Spot and Perpetual, Spot and Expiry, or two Expiry contracts with different dates. The simultaneous execution of these two steps differentiates spread trading from conventional operations.

The Fundamental Concept of Spread Trading

To understand what spread trading is, it is essential to grasp its basic components. A “combo” represents the paired set consisting of two complementary steps with different expiry dates. The “near leg” is the position that expires first, while the “far leg” has a later expiry date.

The “spread” itself is the numerical difference between the entry price of the far leg and the entry price of the near leg. This value can be positive, negative, or zero, depending on the structure of the operation and market conditions.

A critical aspect of spread trading is the atomic order, a mechanism that ensures both legs are executed in equal quantities or not at all. This completely eliminates the risk of partial execution, where one leg is filled and the other is not, leaving the trader exposed to unwanted directional movement.

Why Spread Trading Is Advantageous

Spread trading offers multiple strategic advantages for market participants. First, there is the benefit of a locked spread: once the order is accepted, the difference between the entry prices of the two legs exactly matches the spread specified in the order. This provides predictability and eliminates surprises during execution.

Atomic execution is another fundamental advantage. Since both legs are filled simultaneously in corresponding quantities, the trader is never exposed to single-leg risk— the problematic scenario where only one position is opened.

Operationally, spread trading simplifies the trading process. Instead of managing multiple separate orders in the order book, the trader can structure a complex operation with just a few clicks. This significantly reduces operational complexity.

From a protection standpoint, spread trading functions as an effective hedge. By establishing opposite positions, the trader naturally offsets market volatility, minimizing potential losses from adverse price movements. This delta-neutrality is a distinctive feature of the strategy.

Strategic flexibility is equally important. Spread trading enables the implementation of advanced strategies, including funding rate arbitrage, futures spreads, carry trades, and combinations of Spot and Perpetuals. Its versatility allows adapting the strategy to different market conditions.

Finally, there is an economic advantage: brokerage fees are reduced by 50% compared to submitting two separate orders in the regular order book. For VIP traders, this discount is applied on top of already reduced VIP rates, resulting in significant cost savings.

Instruments and Structure of Spread Trading

Spread trading allows combining various types of financial instruments. The main combinations include Expiry and Spot, Expiry and Expiry (different expiry legs), Expiry and Perpetual, or Perpetual and Spot.

In this structure, instruments are classified by proximity to expiry, from closest to furthest: Spot > Perpetuals > Short-term Expiry > Long-term Expiry.

The order direction determines which leg is bought and which is sold. When buying a combo, the trader buys the far leg and sells the near leg. When selling a combo, the trader sells the far leg and buys the near leg. This convention is fundamental to understanding profit/loss dynamics.

Order parameters include quantity (size of the combo) and order price (desired spread). Once executed, both legs maintain a position of equal size and behave as regular positions in their respective markets.

How Spread Trading Execution Works

Spread trading operates through systematic pairing of instruments with complementary characteristics. The primary goal is to maintain delta-neutral positions, completely eliminating exposure to directional price movements.

When the trader initiates a spread trade, two simultaneous scenarios occur: (1) a long position is opened in one instrument while a short position is opened in the other complementary instrument, both in equal quantities. This balanced structure provides the hedge characteristic of spread trading.

The mechanism ensures that the trader profits specifically from the convergence or divergence of the spread—the difference between the two prices—and not from the overall market direction. If the spread moves as the trader predicted, there is a profit. If it moves against, there is a loss. But in both cases, the exposure to general price movements is neutralized.

After initial execution, both positions behave as regular positions in their respective markets, following standard margin requirements and settlement rules. The trader can manage or close these positions independently, although keeping them paired preserves the hedge benefit.

Essential Calculations in Spread Trading

Calculations in spread trading follow precise formulas to ensure that the order price always reflects the intended spread.

Order price is calculated as the difference between the entry price of the far leg and the entry price of the near leg:

Order Price = Entry Price Far Leg − Entry Price Near Leg

The individual entry prices for each leg are automatically determined based on the order price and the mark prices of both legs:

Entry Price of Far Leg = (Mark Price Far + Mark Price Near + Spread) ÷ 2

Entry Price of Near Leg = (Mark Price Far + Mark Price Near − Spread) ÷ 2

Practical Example of Calculation

Suppose a trader structures a Spot-Perpetual combo with an order price of $50. The Spot index quotes $1,000, and the perpetual mark price is $1,100.

Perpetual Entry Price = ($1,100 + $1,000 + $50) ÷ 2 = $1,075

Spot Entry Price = ($1,100 + $1,000 − $50) ÷ 2 = $1,025

This mathematical precision ensures that the effectively traded spread matches exactly the ordered spread.

Practical Profit Scenarios

Profit or loss in spread trading depends on two factors: the position direction and how the spread behaves until the operation is closed.

Scenario 1: Buying a Combo

When buying a combo, the trader buys the far leg and sells the near leg. Profit occurs when the spread widens, i.e., becomes more positive or less negative.

Consider an example with Expiry and Perpetuals:

If the exit prices are 90 (Expiry) and 89 (Perpetual):

• P&L Expiry: (90 − 85) × 3 = 15
• P&L Perpetual: (88 − 89) × 3 = -3
• Net Profit: 12

If the exit prices are 83 (Expiry) and 90 (Perpetual):

• P&L Expiry: (83 − 85) × 3 = -6
• P&L Perpetual: (88 − 90) × 3 = -6
• Loss: -12

Scenario 2: Selling a Combo

When selling a combo, the trader sells the far leg and buys the near leg. Profit occurs when the spread narrows, i.e., becomes less positive or more negative.

Using the same structure:

If the exit prices are 94 (Expiry) and 83 (Perpetual):

• P&L Expiry: (92 − 94) × 3 = -6
• P&L Perpetual: (83 − 81) × 3 = 6
• Net Loss: 0

If the exit prices are 93 (Expiry) and 83 (Perpetual):

• P&L Expiry: (92 − 93) × 3 = -3
• P&L Perpetual: (83 − 81) × 3 = 6
• Profit: 3

Costs and Savings in Spread Trading

The fee structure is a critical component of the economic viability of spread trading. Brokerage fees for spread trading are significantly lower: 50% less expensive compared to placing two separate orders in the regular order book.

VIP users benefit even more—receiving the 50% discount on already reduced VIP rates. This can lead to substantial cost savings over frequent operations.

Leverage Flexibility

For Spot operations, leverage can be enabled for margin trading or kept disabled for regular Spot trading. Leverage settings can be adjusted individually per leg:

• Spot: up to 10x leverage
• Futures/Perpetuals: up to 100x leverage

Supported Modes and Settings

Spread trading supports multiple operational modes:

Order Types: Limit orders and market orders

Order Strategies: Post-only, Good Till Cancelled (GTC), Immediate or Cancel (IOC), Fill or Kill (FOK)

Position Mode: Unidirectional

Margin Mode: Cross margin and portfolio margin

Conclusion: Spread Trading as a Sophisticated Strategy

Understanding what spread trading is reveals a sophisticated strategy that balances risk protection with potential returns. The combination of atomic execution, locked spread, natural hedge, and reduced costs positions spread trading as a valuable tool for traders seeking arbitrage opportunities without exposure to uncontrolled directional risk.

If you already have experience with derivatives or are looking to diversify your trading strategies, exploring spread trading can open new dimensions of profitability in your investment portfolio.