Excess Spread

  

Excess spread: what happens if you slip during certain yoga poses (they call that the wishbone pose, post-pull).

Also, it describes an additional cushion built into some asset-backed securities.

You’re packaging a bunch of mortgages together to sell as a mortgage-backed security. The mortgages themselves pay an average return of about 5%. You build in some money for your costs and for other fees (insurance, etc.). The total return runs to about 6%.

But you can’t pay the full 6% to the investors in the mortgage-backed securities. What if something goes wrong and the mortgages default at a higher rate than expected? You need some cushion in case of unexpected bad luck.

So you sell them at 4%, using the two percent difference as a buffer. That amount represents the excess spread. The difference between the 6% you receive and the 4% you pay out.

Related or Semi-related Video

Finance: What is Alligator Spread?28 Views

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finance a la shmoop what is an alligator spread.... no it's not that

00:08

an alligator eats the spread from profitable trades to just a break-even [Alligator eats spread]

00:14

trade or worse the alligator is essentially the brokers commission or

00:20

spread however it gets paid which makes a given trade unprofitable like a trader

00:25

bought a stock for $118.23 cents a share thinking she'd sell it the next day for

00:30

$120 even and make a quick buck 77 but then the Commission comes in at a buck

00:36

80 making that particular trade unprofitable well in the real world that [Spread or gross gain from trade pie chart]

00:41

term applies to the options market place where Commission's or spreads can be

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massive as a percentage of the entity being traded that is a bid-ask spread on

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a volatile tech stock might be for a stock trading at 40 bucks a share today

00:54

for about ten weeks of duration a put on it at $35 might be priced as a massive

01:01

$2 a share meaning that in order to make money buying a put option the stock [Put option stock graph]

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would have to decline by more than seven dollars in the next ten weeks that is if

01:11

an investor wanted to buy the put they'd be charged two bucks and if they wanted [Person takes away 2 bucks]

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to sell the put all they could get for it would be like a dollar 20... 80 cent

01:21

spread there if you were trading on the puts and the calls got that then think

01:25

about the put itself well in order to make money buying a put option the stock

01:29

would have to decline by more than seven dollars in the next ten weeks so yeah it [Decline over more than 7 dollars shown on graph]

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gets pretty brutal, careful for those options so let's say a few weeks go

01:36

along and the price of the put that they paid two dollars for now they want to

01:42

sell it because the stocks gone down in the right direction well at dollar 20

01:47

now all that gets a dollar eighty the spread ate them up like alligator ate em [Alligator lurking]

01:51

gobbled up all the profits so yeah when you combine multiple sets of options

01:55

like the above one you can imagine the alligator ends up being painted as well

01:59

very toothy [Man painting and crocodile appears scaring him away]

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