Bid-Ask Spread Formula

Bid-Ask Spread Formula (Table of Contents)

• Bid-Ask Spread Formula
• Bid-Ask Spread Formula Calculator
• Bid-Ask Spread Formula in Excel(With Excel Template)

Bid-Ask Spread Formula

The bid-ask spread is the difference between bid price and asks price that dealers quote and it is the source of dealer’s compensation.

Examples of Bid-Ask Spread Formula

Let’s take an example to find out the Bid-Ask for a company: –

Bid-Ask Spread Formula – Example #1

Let’s take an example of a stock X being quoted in the exchange as $20/21. This indicates that the price at which the dealer is ready to purchase stock X from any investor is $20. This is the bid price for the security X. The price at which the dealer is ready to sell stock X to any investor is $21. This is the asking price for the security X.

Hence we can calculate the bid-ask spread by simply subtracting bid price from the asking price.

• Bid-Ask Spread = Ask price – Bid Price
• Bid-Ask Spread = $21 – $20
• Bid-Ask Spread = $1

Hence the dealer’s compensation on a transaction of security X is $1.

Bid-Ask Spread Formula – Example #2

Currency markets are the most liquid markets across the world hence bid-ask spreads for dealers on these transactions is very low. But the transaction size in these markets is very high which compensates dealers on any transaction.

• For example – The EUR to USD market is currently having the quote of: –
• EUR/USD = 1.1405/1.1425
• EUR to USD indicates that USD is the base currency and hence an investor or dealer will be either purchasing or selling dollars.
• Hence the dealer will buy dollars or sell euros to the investor at 1.1405 and the dealer will sell dollars or purchase euros at 1.1425.

So the bid asks spread for the dealer in this transaction: –

Now, we will find out the Bid-Ask Spread By using the Bid-Ask Spread Formula

• Bid-Ask Spread = Ask Price – Bid Price
• Bid-Ask Spread = 1.1425 – 1.1405
• Bid-Ask Spread = $0.0020

Bid asks spread for the dealer in this transaction is $0.0020

Bid-Ask Spread Formula – Example #3

Let’s say an investor wants to purchase Gold Futures in an Indian Commodity market. The best bid price or the price at which dealer will purchase the future contract is Rs 26473 while the best offer price or the price at which dealer will sell the future contract is Rs 26478 then the bid-ask spread for this particular future contract is: –

Let us calculate the Bid-Ask Spread for this particular future contract

• Bid-Ask Spread = Ask price – Bid price
• Bid-Ask Spread = Rs 26478 – Rs 26473
• Bid-Ask Spread = Rs 5

Explanation of Bid-Ask Spread Formula

Securities or currency dealers provide prices at which they will buy or sell financial instruments. The bid price is the price at which the dealer will buy the security or investor will sell the security. The ask or offer price is the price at which the dealer will sell the security or investor will buy the security. The difference between the bid and ask prices is referred to as the bid-ask spread and is the source of dealer’s compensation.

The bid and ask price for any security is quoted for specific trade sizes. The quotation in the market is the highest dealer bid and lowest dealer ask from among all dealers in a particular security. More liquid securities have bid-ask spreads which are lower and therefore have lower transaction costs for investors. Traders who post bid and offers are said to make a market while those who trade with them at posted prices are said to take the market.

Significance and Use of Bid-Ask Spread Formula

The bid-ask spread is affected by various factors. These factors determine the risk taken by dealers when they purchase or sell any financial instrument and hence they are wider when it is riskier. One of the factors that affect bid-ask spreads is liquidity. Liquidity refers to the number of market participants or volume of that particular instrument traded. If there is a lot of demand for that particular instrument and there are a lot of market participants who want to buy or sell that instruments, then the bid asks spread will be narrower. Similarly, if the instrument does not have a lot of demand then the dealer is taking an additional risk by purchasing or selling the security as the instrument is illiquid, hence the dealer will demand additional compensation which results in wider bid-ask spreads.

Another major factor that impacts bid-ask spread is volatility. Volatility means that there is either huge market demand for any instrument or total loss of demand. In these circumstances, the dealer wants to benefit as much as possible hence the spreads will be wider when volatility is high.

Bid-Ask Spread Calculator

You can use the following Bid-Ask Spread Calculator

Bid-Ask Spread Formula in Excel (With excel template)

Here we will do the same example of the Bid-Ask Spread formula in Excel. It is very easy and simple. You need to provide the two inputs i.e Ask Price and Bid Price

You can easily calculate the Bid-Ask Spread using Formula in the template provided.

In, this template we have to solve the Bid-Ask Spread formula

Conclusion

Bid-ask spread is a difference between the ask price and bid price quoted by the dealer for any financial instrument. If the Bid-ask spread is wider, it indicates there is less liquidity or more volatility for that particular financial instrument. If the bid-ask spread is narrower, then it indicates that there are more liquidity and less volatility for that security.

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