What is a Forward Spread?
A forward spread is the price difference taken at a given interval between the spot value of a security and the forward price of the same security. The formula is demand forward minus spot price.
If the spot rate exceeds the forward rate, then the difference is the spot price less the forward price. Forwards points are another name for the forward distribution.
Breaking Down the Forward Spread
All spreads are simple calculations arising from the price difference between two assets or financial items, such as security on that security and a forward.
The price difference between two maturity months, two different option strike rates or even the price difference between two different locations may also be a spread. For instance, the U.S. spread Treasury bonds traded on both the U.S. futures market and the futures market in London.
For forward spreads, the calculation is the price at the spot market for one asset relative to the market of a forward that will be deliverable at a future date. The forward spread can be based on any period, like one month, six months, a year, etc. The forward spread between spot and one month ahead is likely to be different from the spread between spot and six months ahead.
Using Forward Spreads
Forward spreads offer the supply and demand signal to the traders over time. The more significant the gap, the worthier the underlying asset would be in the future. The smaller the scatter, the more precious it is now.
Narrow spreads, or even negative spreads, can be due to short-term shortages in the underlying commodity, whether actual or perceived. Negative spreads (called discount spreads) often occur with currency futures as currencies have interest rates attached to them which will influence their future value.
