What are Nadex Call Spreads and how do they work?
Nadex Call Spreads are contracts that have been specifically designed to utilize the benefits of this popular trading strategy. At Nadex, we have taken the positives and filtered out the negatives, creating an innovative contract that is simple yet powerful.
Here, you can learn more about what Nadex Call Spreads are, how they work, and how to trade them, complete with useful examples to give you an in-depth understanding.
What is a call spread?
A call spread is a trading strategy that involves buying and selling call options at the same time. Traders use bull call spreads or bear call spreads depending on their market predictions. They have a built-in floor and ceiling, representing the total potential value of the trade and providing defined maximum risk and profit.
This is where Nadex Call Spreads come from. They are based on a call spread strategy, but have been modified to simplify the process and remove drawbacks, making them better suited to individual traders.
What is a Nadex Call Spread contract?
Here is an overview of Nadex Call Spread contracts:
One contract packaged as a single unit. Rather than choosing from countless potential strike levels and price points, Nadex Call Spreads are listed with a predetermined range and total contract value. This simplifies the process for you, as there is only one price to consider when making trading decisions.
Short contract durations. Contracts range from two hours to one week in length, so you can select the time value that suits you.
Small contract sizes. Nadex Call Spreads were designed with the individual trader in mind. Smaller contract sizes open up the world’s most popular markets to traders with a smaller appetite for risk – and if you have a larger account, you can also find the liquidity necessary to scale up your position sizes.
No pattern day trader rule. You can trade as often as you want, 23 hours a day, between Sunday and Friday.
Nadex Call Spreads explained: need-to-know facts before trading
There are several features of Nadex Call Spread contracts that set them apart from other financial instruments. These are the call spread contract fundamentals you need to understand:
Built-in floor and ceiling. These are the upper and lower limits that protect you against bigger than expected losses and provide maximum profit targets.
Bi-directional structure. The structure of a Nadex Call Spread makes it just as easy to trade a market you believe is going down (you’d sell), as one you think is going up (you’d buy).
You can’t lose more than you put into the trade. The maximum potential risk on any trade is known upfront. There are no nasty surprises and never any possibility of a margin call. When buying a Nadex Call Spread, the price level where you buy the contract, minus the floor level, represents your maximum risk. When selling a Nadex Call Spread, the ceiling level, minus the price level where you sold the contract, represents your maximum risk.
Your contract expires at a set time. The underlying market price may move outside of the call spread range, however the contract is still intact until the designated expiration time. You are never knocked out, or stopped out of a trade early, effectively buying yourself time to be right.
You can close the trade early. While Nadex Call Spread contracts have a defined lifespan, there is the possibility to close a trade early to limit losses or lock in profits.
Trading Nadex spreads
When selecting a Nadex Call Spread contract, you will have a few choices to make:
What are your market expectations? If you’re expecting a quick market move, you might choose a contract with a two-hour expiration. If you’re expecting a bigger move over the course of several hours or days, you might choose a longer contract.
What is your price level? You will have a choice of several price ranges, giving you full flexibility.
Once you choose your contract, you will see two numbers in red and blue. These are the bid price and offer price, which sit between the floor and the ceiling. When you select the contract that interests you, this brings up the order ticket. Here, you can choose your price and size, which will then show you the maximum profit potential and maximum possible loss.
As an example, let’s say you predict that the indicative underlying market will rise, so you’ve bought a Nadex Call Spread contract that expires at the end of the day. At this point, these are the possible outcomes.
The contract expires somewhere between the floor and ceiling. If the indicative price has moved up, you make a profit. If it has moved down, you take a loss. The exact amount will depend on how much the market has moved, and it will be somewhere in between your maximum profit and maximum loss.
The contract expires and the indicative price is above the ceiling. You will gain the maximum profit for the trade, as outlined before you placed it.
The contract expires and the indicative price is below the floor. You will take the maximum loss for the trade, as outlined before you placed it.
These are the potential outcomes at expiration, excluding fees. Always keep in mind though, there is the option to close a trade early to lock in profits or limit losses.
An example of trading Nadex Call Spreads
The Nadex platform makes it simple to trade call spread contracts, but you still need to understand the decision-making process before opening a position. Let’s walk through an example of trading call spread contracts. This example uses a Nadex US 500 call spread, which is based on the CME E-mini S&P 500® Index Futures.
These are the key points you need to know about the contract:
Current indicative underlying index: 3357.00
Current bid/offer price: 3357.80/3358.10
Many traders ask the question: ‘Why am I paying more than the price the market is currently at?’ This difference is due to premium.
To understand this concept, think of the way insurance works. The floor/ceiling is protecting you from further loss, no matter how far the underlying market moves – for this protection, you pay a premium. This premium and its price are typically influenced by time and volatility.
Time: the rule of thumb is that the more time there is remaining before expiration, the more premium you will pay to secure the trade. The less time, the less premium. It’s the same as insuring a car for a shorter period: if you’re paying for one month’s protection, you will pay less than you would for a whole year. Short-term contracts let you minimize your exposure to time premium.
Volatility: the more volatile a market is, the more premium required. This could be equated to a bad (or ‘volatile’) driver, who would be required to pay higher premiums than someone who has a safe driving record.
So, back to the trade. You decide to place the following:
Buy one US 500 call spread contract with a range of 3355.00 to 3395.00 at a price of 3358.10.
Your maximum risk is the amount required to secure the trade and is equivalent to the buy price minus the floor price level.
3358.10 - 3355.00 = 3.1, or $31.00 per contract.
You cannot lose more than the $31.00 you put into the trade, excluding fees, regardless of what happens to the indicative underlying index.
To find your profit potential, you must find the difference between the ceiling and the buy price.
3395.00 - 3358.10 = 36.9, or $369.00 (excluding exchange fees).
Here are some potential outcomes:
The market moves lower and when the contract expires, the US 500 indicative index is below the floor. You will lose the $31.00 you put up as collateral to secure the trade (plus exchange fees).
The market moves higher and at expiration the US 500 indicative index is above the ceiling. You will have realized your maximum profit potential of $369.00 (minus exchange fees).
The market moves higher and you close out the position using a limit order at a level of 3385.00. In this case, your profit would be the difference between where you bought (3358.10) and where you sold using the limit order (3385.00). This is a difference of 26.9, or $269.00 (minus exchange fees).
The market moves higher and at expiration, the settlement value is 3375.00. Your profit, in this case, would be the difference between the settlement value (3375.00) and where you bought (3358.10). This is a difference of 16.9, or $169.00 (minus exchange fees).
The market slides sideways before dropping slightly and you decide to cut your losses by closing out the trade at 3356.10. In this case, your loss would be the difference between where you bought (3358.10) and where you sold (3356.10). This is a difference of 2.0, or $20.00 (plus exchange fees).
Learn how to trade call spread contracts
This example takes you through the basics of trading a call spread and explains the different components of the contract. What it doesn’t explain is how you decide which call spread contracts are right for you to trade. That’s because this is an in-depth, ongoing process that will be different for every trader. Here are some resources to help you devise your own trading strategies and use call spread contracts in the way that works for you:
Build a trading plan – this is fundamental to trading and should always be the starting point before you begin placing orders.
Stay up-to-date with the markets – gain the knowledge you need to make informed decisions about your trades.
Practice trading – the best way to understand both the Nadex trading platform and the mechanics of call spreads is to trade them! Trade risk free with a Nadex demo account and take the first step towards trading these innovative contracts.
Are call spread contracts regulated in the US?
Our exchange, and all of our contracts, are regulated by the Commodity Futures Trading Commission (CFTC), a US government agency that works to protect market participants and the public from fraud, manipulation, abuse, and systemic risk in the derivatives markets.
Nadex is registered as a Derivatives Clearing Organization (clearinghouse) and is also a Designated Contract Market (exchange) with the CFTC.
Call spread key takeaways
Call spread contracts offer control and time. These two elements work together to provide unique trading opportunities where you have the time to be right.
Nadex Call Spreads can be the perfect introduction to the markets for new traders, and they can offer something different for those with more experience.
As with any financial instruments, you must take responsibility and trade sensibly, never risking more capital than you can afford.
Want to see what it’s like to trade call spread contracts?
Sign up for a free Nadex demo account. You’ll get $10,000 in virtual funds, so you can practice trading with no risk at all.