How does Spread Betting Work ?


Spread betting is a relatively straightforward way of taking a position in financial market movements by trading world indices like FTSE, Dow and Hang Seng as well as shares, currencies and commodities.

Although closely associated with bookmaking spread betting still falls within the derivatives classification and as such carries a risk warning that you can loose more than your initial deposit if markets work against you.

On the other hand spread betting has the benefit of simplicity, tax-free benefits and ability to trade falling prices profitably offering an alternative to shorting stocks by traditional methods. More on this below.



What is Spread Betting


In its simplist form, traders may take a position in spread betting to speculate on price movements irrespective of whether the markets are rising or falling.

All spread bets are offered with a buy/sell spread and against a chosen time scale. Profit or loss is measure in GBP [pounds] per point.

The best way to explain the benefits of spread betting is by following simple examples.



Spread Betting Examples


Say you thought shares in BP were cheap and were likely to rise in the near future. One way of backing this view would be to invest money in BP by purchasing actual shares in the company. If your view proved to be correct, you could sell your shares at a higher price than you bought them, in order to make a profit.

An alternative way of backing your judgement would be to make a spread bet, backing the price to rise, as shown in the example below.

Buying a Spread Bet


Say it is September. The spread betting price for December BP (a bet that expires at a certain date in December) might be 418 - 421.

If you expect the price to rise, you would make an up-bet, by buying at 421, the higher end of the quote.



Spread Bet Size


As with normal share dealing, the larger your deal size the more you stand to make or lose for a given market movement. However, instead of dealing in numbers of shares or contracts, spread bets are denominated in pounds per point. With some firms you can bet on shares in as little as 1/point.

You might decide to 'buy' 5/point. This means that you make 5 for every point that our price rises above 421 (and you lose 5 for every point it falls below 421). A 5/point bet is the equivalent of buying 500 shares, because in each case a penny movement in the share price is worth 5 to you.



Closing Spread Bets


You were right! BP shares enjoy a good couple of months and by the middle of November the price for December BP is 483 - 486. You decide to take your profit and close your position by 'selling' 5/point at 483, the lower end of the quote.


Closing level

483

Opening level

421

Difference

62

Profit 62 x 5 =

310



Spread Betting compared to Share Dealing


You could take a 5000 long position in BT on the basis of just 500 cash sitting in your account using spread bets.

A 20-a-point "up-bet" on BT shares in September from a starting level of 250 (pence) would give you the same exposure as buying 5000 worth of the shares - because 20 times 250 is 5000.

Your maximum loss from the spread bet would be exactly the same as it would be from buying the shares - in the unlikely event of BT shares falling to zero, you would lose 5000 on both transactions.


The Advantages of Spread Betting ?


Shorting Stocks.

You can use spreadbetting to go long or short of a position. With stock markets being cyclical and often in a bearish phase, it is extremely difficult to make profits as a stock trader without the ability to trade shares that may fall in price. Shorting stocks with spread betting presents a relatively straightford option.



Spread Betting is tax free.

Spread betting is free of the taxes that apply to ordinary share trades. There is no stamp duty on up-bets or down-bets on any spreadbetting trades and any profits also free of capital gains tax.



Spread Betting on world markets.

Spread Betting provides opportunity to trade many different markets from just one online account - British shares, American shares, European shares, stock market indices, government bonds, exchange rates, gold, oil, index options and of course sport and politics.




How does FTSE spread betting work ?


On a particular day, you may be quoted 5200-5210 for the FTSE100 index on 21 June. Your options are to make an up-bet from the top of the spread (5210), or a down-bet from the bottom (5200). You choose your stake size - 1-a-point, 2-a-point, all the way up to 100-a-point or more.

Spread bets can be held all the way to expiry (on 21 June in the case of the FTSE bet above), or they can be closed at a profit, or a loss, any time before that.



Spread Betting Risk Warning


These are high risk instruments regarded in the derivatives class. Companies that run spread betting, although affiliated to city brokerages, are basically run as bookmakers. It is easily possible to loose more than your original stake and spread betting is not for the uninitiated novice investor.