Financial Spread Betting Guide
More and more business papers and supplements are advertising spread betting as an exciting way to gamble on the stock market. But what is it all about and is it just the stock market that you can gamble on ?
McDowell and Co. Accountants, outline the background to this new craze:
What is Financial Spread Betting?
Advantages of Spread Betting
- NO Stamp duty is payable (saving 0.5% compared to a traditional share purchase.
- Tax Free Profits: Profits on spread betting are not subject to capital gains tax*
- No direct commissions or fees are paid to the spread betting company
- You can profit from falling or rising markets
- They are traded on margin therefore bets can be placed with a relatively small initial outlay
- A single account can give you Access to far greater range of financial markets.
- You can limit your risk using a ‘Stop Loss’
- The ability to place very small bets, some companies let you place a trade of as low as 1p per point.
* Tax Laws are subject to change.
- Some markets may be very volatile and unless you place a stop loss you could incur very large losses if your position moves against you
- It is less suited to the long term investor, if you hold a bet open over a long period of time the costs associated increase and it may be more beneficial to have bought the underlying asset.
- You have no rights as an investor, including no voting rights and you will not benefit from dividends.
What can I trade?
Because you are not actually buying or selling the actual underlying instrument. the range of instruments that you ‘bet’ on can be far greater than simply underlying shares.
You can bet on the spread bet of:
- Stock market indices such as the FTSE or NASDAQ
- Individual shares from the FTSE 100 and FTSE 250, but also from leading US and European shares
- Currencies, FX
- Commodities such as metals and oil
- Interest Rates both short term and long term
- Futures and options
How does a Spread Bet work?
A spread bet is a bet on the future movement of an underlying instrument. In basic terms if you believe the underlying instrument is going to rise you place a buy bet, if you believe the underlying instrument is going to fall you place a sell bet. Unlike ordinary share trading you can befit from falling as well as rising shares or other financial instruments.
A spread betting company will quote you two prices for any underlying instrument a Bid (the price that you can sell at) and a ‘offer’ just like you would for a normal equity (the price that you can buy at)the difference between these is known as the spread.
The movement of the underlying instrument is measured in points eg. For equities 1 point = 1 pence for indices usually 1 point = £1 and you can place a bet of any value against every point movement in the underlying i.e. £1 per point, £5 per point or £10 per point etc.
To close a bet you simply place an opposite bet on the specific instrument at the same £ per point. To close a buy bet you sell at the current quote and to close a sell bet you buy at the current quote.
Therefore the profit or loss that you make is the points difference between the opening bet and the closing bet multiplied by the value of your bet per point (i.e. £1 per point, £5 per point or £10 per point etc.)
The best way to understand how a spread bet works is to look at an example
Vodafone is currently trading 130 – 130.5
Investor A believes that Vodafone is going to rise and places a buy bet at 130.5 for £10 a point.
Investor B has the opposite view and believes that Vodafone is going to fall and places a sell bet at 130 for £10 point.
Vodafone rise to 135 – 135.5
Investor A’s prediction is correct Vodafone has risen and he closes his position with a sell bet at 135 and subsequently makes a £45 profit ( 4.5 points x £10)
Investor B decided to cut her losses and closes her position at 135 and makes a £50 loss (5 points x £10)
Vodafone falls to 126 – 126.5
Investor A’s prediction is incorrect and he decides to close his position by placing a sell bet at 126 making a loss of £40 (4 points x £10)
Investor B’s position has move in her anticipated direction and she decides to close her position by placing a buy bet at 126.5 making a profit of £35 (3.5 points x £10)
The theory of spread betting is exactly the same whatever instrument you wish to trade on, one of the most popular forms of financial spread betting is on world indicie such as the FTSE 100 or The Dow Jones :
The FTSE 100 is currently trading at 4367 and XYZ spread.com is quoting a spread of 4363 – 4370 on the Daily FTSE.
Investor A believes that the FTSE is going to rise and places a buy bet at 4370 for £5 per point
A week later the FTSE has risen and the daily FTSE spread is now 4400 – 4406
Investor A decides to place a sell bet at 4400 to close out their position, and they make a profit of £150 (30 points x £5)
Conversely, The FTSE falls and the current FTSE spread is now 4330 – 4336 and Investor A decides to close out his position by placing a sell bet at 4330 and makes a loss of £200 (40 points x £5)
Cost and Margin Requirements
How much does a spread bet cost?
When placing a spread bet the only costs involved are included within the spread, so effectively the wider the spread the more expensive it is to trade.
How much money do I need to place a bet or trade?
Spread betting is traded on margin, which means that you simply need to place a deposit when you open a trade of only a % of the positions total value.
If we compare a spread bet and an underlying share trade a Buy bet on Vodafone at 1.30 for £1 a point is the equivalent of buying 1000 shares at 1.30, if Vodafone rises to 135 bid you would make a profit on the shares of £50 (1000 shares x 5p) with a spread bet you would also have made £50 (5 points x £1).
However in order to buy the actual shares in the traditional manner you would have to pay the full value of £1300 before commission or stamp duty. With a spread bet there will be a deposit requirement based often called margin requirement or notional trading requirement on the value of the trade this will differ between different underlyings and different spread betting companies eg.
The margin requirement on Vodafone is 10% and the amount to pay initially is calculated as follows (£ per point x total number of points) x .10% i.e. £1 x 130 points = 1300 x .10 = £130
Therefore, to open a buy bet on Vodafone at 130p for £1 a point it would require an initial deposit of at least £130
Spread betting companies often offer two types of account a deposit account where you have to have enough money to cover the notional trading requirement on your account or a credit account where by you have a set level of credit against the notional trading requirement. However margin requirement per stock will be important as it will ascertain what size bet that you can open.
If a position moves against you, you may have to pay additional money over the initial deposit this is know as margin or margin call and will be made by the spread betting company if your open positions are running at a loss over and above the . It is therefore advisable that you do not open positions that require all your available funds as an initial deposit or you may be forced to close your position if you can not pay the required margin
It is possible to set certain levels that if reached will automatically open or close a position .
A Limit order is one that is executed at a better price than the prevailing price, ie for a buy bet when the stock drops to a certain level or for a sell bet when the stock rises to a certain level.
|Example: The FTSE spread is currently trading at 4400 – 4406Investor A wishes to place a £10 a point trade with a limit of 4390, therefore they do not wish the order to be opened unless the FTSE spread offer reaches 4390.This order is held by the spread betting company
Two days later the FTSE spread is 4384 – 4390 and an opening trade of £10 a point is opened at the limit level of 4390.
A stop order is one that is executed at a worse price than the prevailing market price one of the most common uses of this is a stop loss order. It is possible to make substantial profits when placing spread bets as well as substantial losses which is why many spread betting firms allow you to place a stop loss when you open a trade:
A stop loss is a price level set by the client on a particular trade that if reached automatically closes out the particular position at the desired price.
|Example: Barclays is trading at 515 – 520Investor A and Investor B both believe that Barclays will rise and both place a buy bets at 520 for £10 a point. However, Investor B also places a stop loss when he opens the trade at 500.
The following day Barclays drops steeply during the day trading down from 515 to 450.
Investor A has not been watching the price of Barclays all day and therefore when he checks the price at the end of the day it is now 450 – 455 and he is running a £700 loss (70 points x £10). Investor B has not been watching the market either however his position has been automatically closed out at his stop loss level of 500 limiting his loss to just £200 (20 points