Spread Betting Legal
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Spread Betting Legal
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Spread betting refers to speculating on the direction of a financial market without actually taking a position in the underlying security. The investor does not own the underlying security in spread betting, they simply speculate on its price movement using leverage. It is promoted as a cost-effective method to speculate in both bull and bear markets.
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A contract for differences (CFD) is a marginable financial derivative that can be used to speculate on very short-term price movements for a variety of underlying instruments.
Stop-loss orders specify that a security is to be bought or sold at market when it reaches a predetermined price known as the stop price.
Day traders execute short and long trades to capitalize on intraday market price action, which result from temporary supply and demand inefficiencies.
An exit point is the price at which a trader closes their long or short position to realize a profit or loss. Exit points are typically based on strategies.
The E-mini S&P 500 is an electronically-traded futures contract representing one-fifth of the value of the standard S&P 500 futures contract.
Futures are financial contracts obligating the buyer to purchase an asset or the seller to sell an asset at a predetermined future date and price.
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Thomas J Catalano is a CFP and Registered Investment Adviser with the state of South Carolina, where he launched his own financial advisory firm in 2018. Thomas' experience gives him expertise in a variety of areas including investments, retirement, insurance, and financial planning.
Spread betting refers to speculating on the direction of a financial market without actually owning the underlying security. It involves placing a bet on the price movement of a security. A spread betting company quotes two prices, the bid and ask price (also called the spread), and investors bet whether the price of the underlying security will be lower than the bid or higher than the ask.
The spread bettor does not actually own the underlying security in spread betting, they simply speculate on its price movement.
Spread betting should not be confused with spread trading , which involves taking offsetting positions in two (or more) different securities and profiting if the difference in price between the securities widens or narrows over time.
Spread betting allows investors to speculate on the price movement of a wide variety of financial instruments, such as stocks , forex , commodities , and fixed-income securities . In other words, an investor makes a bet based on whether they think the market will rise or fall from the time their bet is accepted. They also get to choose how much they want to risk on their bet. It is promoted as a tax-free, commission-free activity that allows investors to profit from either bull or bear markets.
Spread betting is a leveraged product which means investors only need to deposit a small percentage of the position's value. For example, if the value of a position is $50,000 and the margin requirement is 10%, a deposit of just $5,000 is required. This magnifies both gains and losses which means investors can lose more than their initial investment.
Spread betting is not available to residents of the United States due to regulatory and legal limitations.
Despite the risk that comes with the use of high leverage, spread betting offers effective tools to limit losses :
Risk can also be mitigated by the use of arbitrage, betting two ways simultaneously.
Let’s assume that the price of ABC stock is $201.50 and a spread-betting company, with a fixed spread, is quoting the bid/ask at $200 / $203 for investors to transact on it. The investor is bearish and believes that ABC is going to fall below $200 so they hit the bid to sell at $200. They decide to bet $20 for every point the stock falls below their transacted price of $200. If ABC falls to where the bid/ask is $185/$188, the investor can close their trade with a profit of {($200 - $188) * $20 = $240}. If the price rises to $212/$215, and they choose to close their trade, then they will lose {($200 - $215) * $20 = -$300}.
The spread betting firm requires a 20% margin, which means the investor needs to deposit 20% of the value of the position at its inception, {($200 * $20) * 20% = $800, into their account to cover the bet. The position value is derived by multiplying the bet size by the stock’s bid price ($20 x $200 = $4,000).
Investors have the ability to bet on both rising and falling prices. If an investor is trading physical shares, they have to borrow the stock they intend to short sell which can be time-consuming and costly. Spread betting makes short selling as easy as buying.
Spread betting companies make money through the spread they offer. There is no separate commission charge which makes it easier for investors to monitor trading costs and work out their position size.
Spread betting is considered gambling in some tax jurisdictions, and subsequently, any realized gains may be taxable as winnings and not capital gains or income. Investors who exercise spread betting should keep records and seek the advice of an accountant before completing their taxes.
Because taxation on winnings in some countries is far less than that on capital gains or trading income, spread betting can be quite tax-efficient, depending on one's location.
Investors who don’t understand leverage can take positions that are too large for their account, which can result in margin calls . Investors should risk no more than 2% of their investment capital (deposit) on any one trade and always be aware of the position value of the bet they intend to open.
During periods of volatility, spread betting firms may widen their spreads. This can trigger stop-loss orders and increase trading costs. Investors should be wary about placing orders immediately before company earnings announcements and economic reports.
Many spread betting platforms will also offer trading in contracts for difference (CFDs), which are a similar type of contract. CFDs are derivative contracts where traders can bet on short-term price moves. There is no delivery of physical goods or securities with CFDs, but the contract itself has transferrable value while it is in force. The CFD is thus a tradable security established between a client and the broker, who are exchanging the difference in the initial price of the trade and its value when the trade is unwound or reversed.
Although CFDs allow investors to trade the price movements of futures, they are not futures contracts by themselves. CFDs do not have expiration dates containing preset prices but trade like other securities with buy and sell prices.
Spread bets, on the other hand, do have fixed expiration dates when the bet is first placed. CFD trading also requires that commissions and transaction fees be paid up-front to the provider; in contrast, spread betting companies do not take fees or commissions. When the contract is closed and profits or losses are realized, the investor is either owed money or owes money to the trading company. If profits are realized, the CFD trader will net the profit of the closing position , minus the opening position and fees. Profits for spread bets will be the change in basis points multiplied by the dollar amount negotiated in the initial bet.
Both CFDs and spread bets are subject to dividend payouts assuming a long position contract. While there is no direct ownership of the asset, a provider and spread betting company will pay dividends if the underlying asset does as well. When profits are realized for CFD trades, the investor is subject to capital gains tax while spread betting profits are usually tax-free.
Spread betting is a way to bet on the change in the price of some security, index, or asset without actually owning the underlying instrument.
While spread betting can be used to speculate with leverage, it can also be used to hedge existing positions or make informed directional trades. As a result, many who participate prefer the term spread trading. From a regulatory and tax standpoint it may be considered a form of gambling in certain jurisdictions, since no actual position is taken in the underlying instrument.
The majority of U.S.-based brokers do not offer spread betting, as it may be illegal or subject to overt regulatory scrutiny in many U.S. states. As a result, spread betting is largely a non-U.S. activity.
Investopedia does not provide tax, investment, or financial services and advice. The information is presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future performance. Investing involves risk, including the possible loss of principal.
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Spread Betting: What It Is & How It Works
Updated: May 20, 2022 Written By: Stephen Simpson Reviewed By: Jason Kirsch, CFP
Stephen Simpson is a freelance financial writer and investor. Spent close to 15 years on the Street (sell-side, buy-side, equities, bonds); now a semi-retired raccoon rancher. That last part isn't entirely true. Probably.
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The use of leverage is one way for an investor to enhance their returns, with the accompanying risk of magnifying the losses. There are several means to employ leverage. One option for some investors is to engage in what is called spread betting. While spread betting strains the definition of investing, it is nevertheless a way to make money from stocks, indices, and other types of securities through the use of considerable leverage.
Simply defining spread betting can be controversial; it can be defined as a derivative investment strategy, but it can also be defined as gambling. Further blurring the distinction, most spread betting companies refer to themselves as “brokers”, and many of these “brokers” openly refer to a spread betting transaction as a “bet”.
Spread betting is essentially speculating on the future direction of a specified financial instrument like an individual stock or index by making a directional bet with the spread betting company. The bettor chooses the security in question (like an individual stock or stock index), decides on the size of the bet, puts up a small percentage of the notional trade value as collateral (margin), and then profits or loses money depending upon how the price of the underlying security moves.
With financial spread betting, participants never own (and never can own) the underlying financial instrument. When an investor buys shares in a company, they become literal part-owners of that company, and when an investor buys a commodity futures contract there can be at least a technical possibility of taking physical delivery of the commodity, though most futures are settled in cash.
Spread betting is illegal in the United States as of this writing. Most spread betting companies in the U.K. will not open spread betting accounts from U.S. residents but may offer Contract for Difference (or CFD trading).
Tip: Spread betting used to be legal in the United States and was conducted at places called "bucket shops". Bucket shops were blamed for contributing to two market crashes in the early 1900s, with the practice eventually banned in the early 1920s. Investors can read more about bucket shops in Edwin Lefevre's book 'Reminiscences of a Stock Operator'.
Just as with betting on a horse race or sporting event, spread bettors win or lose money based upon the outcome of the bet, though spread betting is not an all-or-nothing proposition like sports betting. It’s also important to note that the word “spread” means something different with financial spread betting than the term “spread” as it applies to sports betting.
Likewise, spread betting and spread trading may sound similar, but they are very different. Spread trading involves simultaneously buying and selling related financial instruments to profit from a change in the underlying difference in value (the spread) between the instruments.
For instance, traders can play the “crush spread”, the difference between the value of a soybeans futures contract and the value of soybean meal and soybean oil contracts. This difference is the profit margin for processing soybeans into soybean meal and soybean oil and it can shrink or expand for a variety of reasons. If a trader believes that that margin is likely to change, they can engage in spread trading by simultaneously buying and selling soybean, soybean meal, and/or soybean oil contracts to profit from that change.
The would-be bettor decides what security they wish to bet on from among those offered by a spread betting company.
The bettor then decides on the stake size—how much they want to bet on each point , or the minimum movement in the security price. A point will typically be equal to a penny per share for a stock and a point for a stock index futures contract but can vary for other instruments like commodities. In other words, a bettor can make a bet that will pay (or lose) £5 for every penny that a stock goes up or down or every one-point change in the value of an index futures contract.
The stake size determines the notional amount of the bet—a £1 stake for a stock trading at £15 means a notional trade value of £1,500 (£1 per penny).
However, a £3 stake for a stock trading at £30 would have a notional value of £9,000.
The notional amount of the bet determines the required minimum margin, which can range from under 5% to 20% depending upon the security and the spread betting company.
Once the minimum margin is in place, the bet is executed, with the bettor paying the worse of the offered spread (buying at the higher ask price or selling at the lower bid price). The bettor can end the bet at any time, doing so by reversing the transaction (selling at the bid price or buying at the ask price).
Spread bets have durations. Generally, bets either expire at the end of the day or at the end of a quarterly period (more typical with futures contracts).
To better understand how spread betting can work, consider the following example, which first includes an example of a regular stock transaction:
An individual wishes to day trade in the shares of XYZ Plc, and those shares currently trade at a bid/ask spread of £100.00/£100.10, with a brokerage charging a £5 commission to buy or sell.
The individual decides to buy 100 shares and the trade is entered in the morning at £100.10 with a £5 commission, for a total cost of £10,015.
During the day the price of XYZ Plc shares increases by £5/share and the trade is closed successfully at a bid price of £105, with another £5 commission. The individual now has £10,495, earning £480 (before considering taxes).
In this example, the individual needed to have the £10,015 from the start of the transaction, or employ margin.
Now consider that transaction as a spread bet.
First, that individual must decide on their bet size, also known as the “stake” – the amount of money they’re committing to each minimum price move of the underlying instrument. In this case, the investor chooses a stake of £1 per “point” (the point is the minimum price move for the instrument, in this case, £0.01 per share).
While XYZ Plc is trading at £100.00/£100.10 on the stock exchange, the spread offered by the spread betting company is £99.90/£100.20. In this case, then, the notional amount of the transaction is £1/point times the spread betting company’s ask price, or £10,020
The broker requires a 20% deposit, or £2,004 .
As in the prior example, the share price of XYZ Plc increases by £5/share and the investor decides to close the bet before the end of the day, selling at the betting company’s new bid price of £104.90. The profit from the bet is £470.
((£104.90 - £100.20) x £1 per £0.01) = £470
That is almost the same profit as in the earlier example ( £ 480), but there are no taxes later, and the return on initial investment is much larger—more than 23% (£470/£2,004) versus 4.8% (£480/£10,015).
Now consider an example where the value of XYZ Plc shares falls. In this case, the share price falls just £2 to £98.00/£98.10, with the bettor seeing a spread of £97.90/£98.20 from his spread betting company. The value of the bet has now declined by £230.
(£100.20 - £97.90) x £1 per £0.01 = £230
This leaves £1,774 from the original deposit, or a 11% loss .
If the investor had purchased the shares and seen a similar decline, the loss would have been £205 just over 2%, and that loss would be tax deductible.
(((£100.10 - £98) x 100) - £5) / £10,015 = 2%
In this example, the person bought and sold within a day. This is an important detail because of the impact of financing/holding costs. If the share price hadn’t moved at all (ending the day at a bid/ask of £100/£100.10) and the individual chose to carry over the trade to the next day, it would incur an extra cost of around £7 to £9 (at typical spread betting company rates as of this writing). That cost would be incurred every day the trade was open while acquiring the shares for cash would incur no day-to-day costs.
Since spread betting involves large amounts of leverage, risk control is a key concern and a key element to long-term success. Setting maximum allowable losses is a useful strategy for limiting risk and can be achieved through stop loss and guaranteed stop loss orders.
A stop loss order allows a spread bettor to limit risk by establishing a pre
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