Spread Betting Made Easy
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Spread Betting Made Easy
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Spread betting allows traders to bet on the direction of a financial market without actually owning the underlying security. Spread betting is sometimes promoted as a tax-free, commission-free activity that allows investors to speculate in both bull and bear markets, but this remains banned in the U.S. Like stock trades, spread bet risks can be mitigated using stop loss and take profit orders.
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Spread betting refers to speculating on the direction of a financial market without actually owning the underlying security.
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Spread betting is a derivative strategy, in which participants do not own the underlying asset they bet on, such as a stock or commodity. Rather, spread bettors simply speculate on whether the asset's price will rise or fall, using the prices offered to them by a broker.
As in stock market trading, two prices are quoted for spread bets—a price at which you can buy (bid price) and a price at which you can sell (ask price). The difference between the buy and sell price is referred to as the spread. The spread-betting broker profits from this spread, and this allows spread bets to be made without commissions, unlike most securities trades.
Investors align with the bid price if they believe the market will rise and go with the ask if they believe it will fall. Key characteristics of spread betting include the use of leverage, the ability to go both long and short, the wide variety of markets available, and tax benefits.
If spread betting sounds like something you might do in a sports bar, you're not far off. Charles K. McNeil, a mathematics teacher who became a securities analyst—and later a bookmaker—in Chicago during the 1940s has been widely credited with inventing the spread-betting concept. But its origins as an activity for professional financial-industry traders happened roughly 30 years later, on the other side of the Atlantic. A City of London investment banker, Stuart Wheeler, founded a firm named IG Index in 1974, offering spread betting on gold. At the time, the gold market was prohibitively difficult to participate in for many, and spread betting provided an easier way to speculate on it.
Despite its American roots, spread betting is illegal in the United States.
Let's use a practical example to illustrate the pros and cons of this derivative market and the mechanics of placing a bet. First, we'll take an example in the stock market, and then we'll look at an equivalent spread bet.
For our stock market trade, let's assume a purchase of 1,000 shares of Vodafone (LSE: VOD ) at £193.00. The price goes up to £195.00 and the position is closed, capturing a gross profit of £2,000 and having made £2 per share on 1,000 shares. Note here several important points. Without the use of margin, this transaction would have required a large capital outlay of £193k. Also, normally commissions would be charged to enter and exit the stock market trade. Finally, the profit may be subject to capital gains tax and stamp duty.
Now, let's look at a comparable spread bet. Making a spread bet on Vodafone, we'll assume with the bid-offer spread you can buy the bet at £193.00. In making this spread bet, the next step is to decide what amount to commit per "point," the variable that reflects the price move. The value of a point can vary.
In this case, we will assume that one point equals a one pence change, up or down, in the Vodaphone share price. We'll now assume a buy or "up bet" is taken on Vodaphone at a value of £10 per point. The share price of Vodaphone rises from £193.00 to £195.00, as in the stock market example. In this case, the bet captured 200 points, meaning a profit of 200 x £10, or £2,000.
While the gross profit of £2,000 is the same in the two examples, the spread bet differs in that there are usually no commissions incurred to open or close the bet and no stamp duty or capital gains tax due. In the U.K. and some other European countries, the profit from spread betting is free from tax.
However, while spread bettors do not pay commissions, they may suffer from the bid-offer spread, which may be substantially wider than the spread in other markets. Keep in mind also that the bettor has to overcome the spread just to break even on a trade. Generally, the more popular the security traded, the tighter the spread, lowering the entry cost .
In addition to the absence of commissions and taxes, the other major benefit of spread betting is that the required capital outlay is dramatically lower. In the stock market trade, a deposit of as much as £193,000 may have been required to enter the trade. In spread betting, the required deposit amount varies, but for the purpose of this example, we will assume a required 5% deposit. This would have meant that a much smaller £9,650 deposit was required to take on the same amount of market exposure as in the stock market trade.
The use of leverage works both ways, of course, and herein lies the danger of spread betting. As the market moves in your favor, higher returns will be realized; on the other hand, as the market moves against you, you will incur greater losses. While you can quickly make a large amount of money on a relatively small deposit, you can lose it just as fast.
If the price of Vodaphone fell in the above example, the bettor may eventually have been asked to increase the deposit or even have had the position closed out automatically. In such a situation, stock market traders have the advantage of being able to wait out a down move in the market, if they still believe the price is eventually heading higher.
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.
Arbitrage opportunities arise when the prices of identical financial instruments vary in different markets or among different companies. As a result, the financial instrument can be bought low and sold high simultaneously. An arbitrage transaction takes advantage of these market inefficiencies to gain risk-free returns.
Due to widespread access to information and increased communication, opportunities for arbitrage in spread betting and other financial instruments have been limited. However, spread betting arbitrage can still occur when two companies take separate stances on the market while setting their own spreads.
At the expense of the market maker, an arbitrageur bets on spreads from two different companies. When the top end of a spread offered by one company is below the bottom end of another’s spread, the arbitrageur profits from the gap between the two. Simply put, the trader buys low from one company and sells high in another. Whether the market increases or decreases does not dictate the amount of return.
Many different types of arbitrage exist, allowing for the exploitation of differences in interest rates, currencies, bonds, and stocks, among other securities. While arbitrage is typically associated with risk-less profit, there are in fact risks associated with the practice, including execution , counterparty, and liquidity risks. Failure to complete transactions smoothly can lead to significant losses for the arbitrageur. Likewise, counterparty and liquidity risks can come from the markets or a company’s failure to fulfill a transaction.
Continually developing in sophistication with the advent of electronic markets, spread betting has successfully lowered the barriers to entry and created a vast and varied alternative marketplace.
Arbitrage, in particular, lets investors exploit the difference in prices between two markets, specifically when two companies offer different spreads on identical assets.
The temptation and perils of being overleveraged continue to be a major pitfall in spread betting. However, the low capital outlay necessary, risk management tools available, and tax benefits make spread betting a compelling opportunity for speculators.
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Spread betting is a deceptively simple piece of jargon. On one hand, it is theoretically simple but in practise, there can be a lot of things that you’ll have to bear in mind. This financial trading strategy can result in strong returns but to do so without being properly informed raises the risk of losing money rapidly. In fact, many retail investor accounts lose money when spread betting.
So, read on to find your comprehensive guide to spread betting in financial markets.
Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 76% of retail investor accounts lose money when trading spread bets and CFDs with this provider. You should consider whether you understand how spread bets and CFDs work, and whether you can afford to take the high risk of losing your money.
To put it simply, financial spread betting is a flexible way to trade derivatives. Essentially, this strategy allows you to speculate on whether an investment will rise or fall in value.
However, with spread betting, you don’t have to actually take ownership of the underlying asset. Furthermore, profits made from financial spread betting are typically tax-free and exempt from Stamp Duty.
This can make it a potentially attractive strategy for investors, as it offers them the chance to make significant amounts of money as there is no tax to eat into their profit margins.
Of course, it can also be very risky and, as I mentioned earlier, many retail investor accounts lose money if they aren’t careful. This is why it’s important to do your research before you start spread betting.
Essentially, financial spread betting works by using bets instead of actually buying and selling assets physically. For example, in a traditional trade, you might buy a share in Company X, hold it while it appreciates in value, and then sell it for a profit.
With spread betting, you can make that profit by betting that the shares in company X will increase in value. The further that this value moves in the direction you chose, the more profit you can make.
That means you can make money on both rising and falling markets if you correctly predict and bet on shares that subsequently move in that direction.
Of course, this goes both ways, as if the underlying market moves away from you, the greater your financial loss will be.
All of this might sound confusing, but as you’ll see with this spread betting example, it’s often more simple than it sounds.
Let’s assume that you want to spread bet on shares in Company X, which are worth £201.50 each. In this scenario, your broker is quoting the ask at £200 and £203 for you to act on.
In this spread betting example, let’s also say that you think this stock will fall in value, so you hit the bid to sell at £200. You also decide to spread bet £10 for every point that the stock falls to below £200.
If the value of the stock fell to £185, you could close your trade with a profit of £150. (£200-£185= £15) x £10 = £150
On the other hand, if the sell price rose to £220 then you would lose £200. (£200-£220= -£20) x £10 = -£200
Typically, many spread betting platforms will also allow you to trade in CFDS (contracts for difference), which are somewhat similar. Essentially, these are derivative contracts where investors can bet on short-term price moves.
While CFD trading allows investors to trade the price movements of futures, they are not futures contracts themselves. CFDs also don’t have an expiration date with preset prices, but rather trade like any other security.
On the other hand, spread bets do have a fixed expiration date from when you first place the bet. CFD trading also typically involves a greater amount of commissions and transaction fees.
However, there are some similarities. For example, both spread bets and CFDs are subject to dividend payouts if you take a long position contract. While you do not actually own the underlying asset, your spread betting provider or company will pay you dividends if the asset does well.
Such distribution of dividends can be a hugely useful part of a spread betting or CFD trading strategy, providing another way to make money on your investments.
Of course, one issue to note is that when you make a profit from trading CFDs, it is subject to Capital Gains Tax. Conversely, any profit made from spread betting is tax-free. Interestingly, both CFD trades and spread bets are exempt from Stamp Duty.
If you want to know more about trading CFDs, read my guide to the best CFD trading platforms to find out everything you need to know.
When you open a spread bet, you’ll be able to see two prices listed. These are the “buy” or “bid price” and the “sell price”. You can then use the buy or sell price to help you decide whether you want to go long or short.
If you think your chosen asset’s price will rise, then click buy. If you think the value will fall, then you instead click sell.
When you want to close a spread bet, you essentially just trade in the opposite direction to when you first opened it. This means that if you bought to enter the trade, you would have to sell to exit it, and vice versa.
Spread betting can allow you to speculate on the price movement of a wide range of financial instruments. This can include stocks and shares, forex, and commodities.
Since you are essentially betting on whether the market will rise or fall, it can seem like a fairly simple strategy, which makes it attractive to many investors. Furthermore, the proceeds of these investments are often paid free from tax, such as Capital Gains Tax. This can allow you to easily profit from bull and bear markets.
Another thing to note is that spread betting is a leveraged product. As I mentioned in my previous guide about leverage in trading , this means you only need to deposit a small fraction of the trade’s value.
As I previously mentioned, while you can potentially earn large amounts of money by spread betting, there is also the potential for losing money rapidly due to leverage if you aren’t careful about it. According to figures from the Financial Conduct Authority, published by the Independent , more than three-quarters of retail investor accounts lose money when trading using this strategy.
If you want to avoid this high risk of losing, it’s important to consider risk management tools and steps. Thankfully, there are a couple of things you can do here.
A “stop-loss” order reduces the risk that you are exposed to by automatically closing a trade when the market reaches a certain price level. Typically, for a standard stop-loss, the order will close the trade at the best possible buy or sell price, depending on what you instruct.
As you might imagine, this means there is a small delay between the reaching of the value and the close. As a result, if the market is particularly volatile, it is possible that your trade could be closed out at a worse price than that of the stop trigger.
This is similar to a standard stop-loss order, though it guarantees to close your trade at the exact value that you have set, regardless of any of the underlying market conditions. This can give you much greater peace of mind to know that you won’t make any unexpected losses.
However, there is one downside to this, as you will typically be charged a fee to put a guaranteed stop-loss order in place.
While it can be risky, spread betting can be a potentially lucrative way to invest. Here are some of the main benefits of this strategy:
One of the biggest advantages of spread betting is that you can bet on both rising and falling prices, letting you take advantage of both bullish and bearish markets.
Furthermore, if you were trading physical shares, you would have to borrow the stock that you intended to short sell. This can be both time-consuming and potentially costly, but spread betting makes short-selling just as easy as buying.
Another benefit of investing in this way is that you typically do not have to pay any commission or extra fees on your trades. This is because spread betting companies usually make their profit through the spread that they offer to investors.
Since there are no extra charges or fees, it can be easier for you to keep an eye on your trading costs and accurately assess your spread betting position size.
Of course, as I mentioned earlier, if you want to take advantage of a guaranteed stop-loss order then you may have to pay a small charge for that.
Bear in mind that some platforms may charge commission or other fees. Make sure you know what these are before you start spread betting. It’s also often sensible to only spread bet with a broker or company registered with the Financial Conduct Authority.
Since it’s often considered to be gambling in some countries, any spread betting profits that you make from trades may be tax-free from costs such as Capital Gains Tax or Stamp Duty.
Of course, this isn’t always the case, and you may see your spread bets taxed. So, if you want to start spread betting, you may want to keep accurate records and seek professional financial advice, in case you run into any unforeseen tax issues.
Bear in mind that tax treatment may also vary depending on local law and tax rules in the p
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