Market Overview

Misconceptions About Trading Nadex Spreads On Futures

Many traders new to Nadex often make the false assumption, that trading an option on a future and trading a future itself work and move the same way.

There are similarities, but there are also differences. As the saying goes, apples need to be compared to apples, not apples to oranges.

Options, by their very nature, have a wider bid/ask spread due to trade volume. In addition, the market makers use the bid/ask spread to account for risk while they are trying to be delta neutral. So to really compare spreads to futures, one needs to compare futures options to Nadex spreads to get an apples-to-apples comparison.

Bid/Ask Spread

On Nadex, the bid/ask spread on the US 500, which uses the S&P 500 Emini Futures as its basis, is about $5. It takes five spreads to equal one ES futures value of $50 in a one point move. That would be $25 of total bid/ask spread for five US 500 Nadex Spreads. On ES, the most liquid US index future, the bid/ask spread is one tick, which is worth $12.50.

Related: What Is A Nadex Spread?

The US 500 spreads are only two ticks, compared to one tick, on the derivative in value. This is an acceptable amount and not as outrageous as some may first think.

Ability to Ratio Size

One can also trade 1/5 the size of the S&P 500 using a Nadex Spread, versus the minimum size of one contract on ES. Therefore, traders can risk in increments of $10 per one point move versus a minimum of $50 increments per one point move. So by using Nadex spreads, traders can risk less and have a better margin. Using Nadex spreads, traders can buy in amounts that are not multiples of five, allowing for more choices in risk.  For example, a trader could buy two contracts ($20 per point), or seven contracts ($70 per point).

However, on ES, traders must trade one future contract ($50 per point) or two future contracts ($100 per point). The risk compounds instead of adds. So this would be the equivalent of having to trade five spreads ($50 per point) or 10 spreads ($100 per point). There is no in-between on ES futures and no smaller ratios to better manage risk percentages per trade like traders can with a Nadex spread.

Liquidity of Future Impacts Bid/Ask Spread of Options

TF is much less liquid than ES. Stop market orders aren't even allowed on ICE, the exchange for the Russell 2000 (TF), only stop limit and market orders are allowed. Some brokers simulate a stop market order, but that means the order is really sitting on the user's computer, not at the exchange.

Since TF is a less liquid future and an even less liquid option, the bid ask spread is wider. The bid/ask on TF options is similar to that of Nadex spreads, and this is a fair comparison.

Related: How To Never Get Stopped Out Of A Trade Using Nadex Spreads

TF options easily have an $0.80 bid/ask spread x 100 options per contract on ICE, so about $80.00 bid/ask spread on a single option.  Nadex spreads on Small Cap 2000 (TF) usually have a bid/ask spread of about $5.00. 10 Nadex spreads equal one ICE call/put option, so that comes to a $50.00 bid/ask spread. The bid/ask spread can be even less on Nadex than it is on many TF Call/Put options.

Advantages of Spreads over Futures And Future Options

One of the biggest advantages is the capped risk on Nadex, something traders don’t get with the TF. On TF you have to trade whole contracts -- risking $10 per one tick move. With Nadex spreads, traders only have to trade one spread -- risking only $1 per tick move, per spread. In addition, fees on Nadex are capped at 10 contracts, which saves traders money on larger positions.

This is also true for the futures options as traders must do 50 options on one contract on an ES call or put. A Nadex spread would be equivalent to 10 options. So traders can even trade the spreads on Nadex in ratios that are smaller than futures options.

For more information on Nadex spreads and how to trade them and get access to the free spread scanner, go to www.apexinvesting.com, a service provided by Darrell Martin.

To practice trading spreads on a free demo account go to www.nadex.com and click on trading demo trading account.

Posted-In: Binary Options Education Futures Commodities Options Forex Markets General

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