There are several distinct advantages in using a company like IG Index or Capital Spreads, compared to a traditional stockbroker. The reason why spread bets are particularly attractive and why they have become so popular in the UK are a combination of the following:
- Spread bets carry valuable tax benefits. Spread betting gains are exempt from UK stamp duty and profits are completely tax-free. Traditional profits from futures trading are subject to your full marginal rate of tax. You lose at least 20% and possibly 40%.
- Being margined transactions, they offer leverage which allows for greater flexibility with your money.
- They allow for shorting of the underlying asset without having to borrow the stock or pay a funding charge.
- You can make small bets, much smaller than the usual minimums allowed in trading futures directly. Some even allow you to make bets in pence!
- You can trade a huge number of different markets. Individual shares, stock indices, commodities interest rate futures, and bonds, to name a few, can be traded via spreadbets on a single account.
- You can deal immediately. They quote a price, and if you take it, the deal is done on the spot. You do not have to wait for the deal to be executed.
So what are the advantages of spread betting?
As we have already mentioned above the tax advantages and the opportunity for leverage provide the ideal conditions for speculative trading. The advantages to spread betting are that one can do smaller size than the underlying (usually), use more leverage, and in things like FTSE 100 shares the inital transaction costs are probably less. They also allow you to go short as easily as long, which makes hedging straightforward. Then there’s the tax issue. None of these are usually going to be very useful aside from small size and the tax advantage – and the latter is very often trumped by the disadvantages.
For instance if you are trading British Airways shares at £25 per point, in terms of exposure, that would be the equivalent of buying 2500 shares of British Airways. Normally such a transaction, not including broker fees and commissions would cost you £6862.50 with British Airways trading at 274.50p (2.745 x 2500). However, as a spread trader, in order to open this position, you would only have to put down 5% to 10% of that. However, beware that if you were to put down just £343, the shares would only have to fall by 14p to lose your initial deposit or more. Similarly they could rise and you would make a profit.
One particularity to spread betting is the ability to access a multitude of different markets all through the one interface. This allows spreadbetters to take advantage of opportunities in thousands of different markets via the most appropriate instrument. Traders and investors also like financial spread betting and CFDs because their potential for return is equally balanced. If you win, you win, and if you lose, you lose. As opposed to traditional shares dealing, investors are able to gear their spread betting positions to take advantage of market conditions but aren’t handicapped with associated costs of stamp duty for rapidly dealing in and out of positions.
Spread betting may be better for short term trading than dealing in shares especially if you like to build stakes in a position or exit a trade in stages as you don’t have to keep paying commission, obviously there is still the market and providers’ spread to think about.
‘Handled with care, I think spread betting gives the best over-all picture of the markets and all its tributaries. I’ve learnt things from the first 5 months of spread betting that I would never have done trading standard shares or reading financial articles. Therefore, consider spread betting a training regime, to allow you to understand the financial markets (forex, equities, fixed income, commodities) and how they all link together. Then you can bring that knowledge back into the trading of basic equities or whatever you want to do.’
Spread Betting Pros and Cons
- Gains can be made in both rising and falling markets
- Leverage (i.e. margin trading) means that profits can be magnified.
- Access to a wide range of financial instruments
- No stamp duty
- No capital gains tax on any profits from spread betting
- Losses can be magnified as you are trading on margin
- Losses can exceed your original capital outlay
- Losses from financial spread betting cannot be offset against other capital gains.
“Most investors and traders like the fact that everything can be done from a single account irrespective of whether they want to hedge currency exposure or trade Australian stocks. It saves them from having to deal with four or more brokers.”