| Financial Spread Betting |
Article researched and written for Fill ya Boots! by Daniel Turner In the last few
years a new form of betting has become increasingly popular – spread betting.
This guide explains the basics of what spread betting involves and why it
is seen as an attractive way to gain exposure to financial instruments. The
Basics Spread betting revolves around the fact that people disagree. The spread betting company makes a prediction of the price of a financial instrument at some point in the future. This takes the form of a spread, much like that on a share. If you think this is too low you would “buy” at the higher price and if you believe it is too high you would “sell” at the lower end of the spread. You bet in units of £ per point. An example: It’s 9am and the FTSE 100 index is currently trading at 6210. The spread betting company is quoting an end-of-day spread of 6212 – 6220. You are betting £5 per point. Case 1 - You believe the FTSE 100 index will end the day higher than their prediction. Therefore, you buy at 6220. Case 2 - You believe the FTSE 100 index will fall. You sell at 6212. Case 3 - You agree with the spread betting company so do nothing.
Scenario
1 The
Dow opens strongly and the FTSE rallies to close at 6250. Case 1 – You bought the market at 6220. You make a profit of (6250 – 6220) x £5 per point = £150 Case 2 – You
sold the market at 6212. You make a loss of (6212 – 6250) x £5 per point = -£190 Scenario 2 Vodafone says it will not meet 4th quarter earning targets and the market falls to 6100. Case 1 – You
bought the market at 6220. You make a loss of (6100 – 6220) x £5 per point = -£600 Case 2 – You
sold the market at 6212. You make a profit of (6212 – 6100) x £5 per point = £560 The spreads fluctuate with the underlying instrument in real-time and you can bank a profit or limit a loss at any time by closing the trade. This is done by “buying” at the high end of the spread if you were short, and “selling” at the low end of the spread if you were long. Limited Risk Bets An investor can chose to protect their bet against extreme adverse movements by setting pre-determined stop loss levels. If the instrument falls below/rises above these levels the bet is automatically closed at the level of the stop loss. Spread betting companies charge for this security in the form of wider spreads. Stop Loss This works in much the same way a limited risk bet, except the closing trade is not guaranteed to be executed at the stop loss level. Limit Order The opposite of a stop loss. This is a pre-determined level at which a profit is taken. Why
Use Spread Betting? Leverage This is the relationship between risk and capital. Spread betting is highly leveraged, i.e. you can gain a large exposure to the market while having a smaller amount of capital. This is one of the reasons why spread betting can be a risky game. E.g. you have a view on a particular stock that is currently trading at £10. You think the stock will go up so you buy the spread on that stock @ £10 per point. This is the equivalent risk to owning 1000 shares (1000 x 1p = £10), which at the price of £10 would cost £10 000. However, the notional trading requirement
(i.e. the amount of money you need in your account) may be something around 10%
(or £1000). So you have the same
risk as if you had invested £10 000, while only having £1000. Variety Instruments that can be traded using financial spread betting include:
So you can see that spread betting gives private investors the opportunity to gain exposure to instruments that would otherwise be difficult to become involved in. Hedging If you own a large portfolio of shares, but feel that there will be a short-term correction in the market spread betting can be used to reduce your risk in the market. This could be achieved by selling the spread on a market future. You would still lose the same amount on your shares if the market fell, but now you would recoup some (or all) of that from being short the spread-betting equivalent of a future. This is preferential to the hassle of selling all your shares and buying them back again, which would incur both dealing charges and stamp duty. This leads on to one of the strongest arguments in favour of spread betting. Costs and Taxes There is no stamp duty, dealing charges or capital gains tax payable when involved in spread betting. The spread betting firm makes it’s money from people crossing the spread, i.e. some people selling the lower price and some people paying the higher price. That way the company makes the difference. Spread betting companies also hedge themselves in the markets where the spreads on instruments are often lower (e.g. the spread on the FTSE near-month future is often only 1 or 2 points). Finally… This guide is just a brief introduction to the world of spread betting. If you are seriously considering getting into spread betting I would recommend that you visit the sites of companies who provide the service, some of whom are listed below, and make sure you understand the risks! Spread betting can be a useful tool for investors, but carries a serious wealth warning if not used properly. Used recklessly, or without a deep understanding of how it works it can be a quick and painful way to lose a lot of money. The ability to gain such large exposure for a relatively small outlay is potentially dangerous and we would advise caution in its use. Article researched and written by Daniel Turner |
