Why not CFDs as opposed to Spreadbets? CFDs are used by most hedge funds…

Really CFDs and spread bets are really quite similar products. For instance, both spreadbets and CFDs are leveraged derivative products that are exempt from stamp duty and both allow a speculator to ‘bet’ on the price movement of an underlying asset without having to physically own the product. However there are some key differences. Under current UK law, neither may be subject to stamp duty. However where spread betting is exempt from capital gains tax, CFD trading is not.

There used to be more differences in the past between CFD trading and spread betting but the differences are now blurring. Negatives of spread betting years ago used to be skewed prices (compared with the cash price) but spread betting firms now offer daily rolling contracts that mirror exactly the cash price. Today you can get spreadbetting for index futures that mirror tick for tick EXACTLY. Why not just trade the futures? Again, it comes down to tax.

Spread Betting and CFDs Compared

The only real advantage to CFDs is the ability to trade directly on the order book. A problem with DMA CFD is that if you make multiple fills these are charged at £10 a pop, and unless you are trading a minimum of £5k+ per trade, these can add up. Apart from that, the down side is the same as spread betting i.e. the cost is higher the longer you hold. A difference is in the way the two products are paid for. In spread betting, the price is build into the bid-offer spread, the difference between the buying and selling price that must be covered by the spread trader before a profit can be made. Some CFD providers also use this system for pricing contracts but in some cases they may choose to charge a commission charge instead.

“CFD = contract for difference. You’ve entered into an OTC contract with a bookie for the difference in the price from T to T1 for whatever financial instrument. If the shares go to zero then you’ve got your difference in it. The only real difference for a UK investor nowadays is that with contracts for difference (CFDs) you are subject to UK capital gains tax, including tax on dividend income. Because, similar to financial spread betting, you are not purchasing actual shares in a company, UK traders do not have to pay stamp duty when trading CFDs, but they are still liable to Capital Gains Tax, though the first £10,100 is exempt from tax. This has both advantages and disadvantages. Losses incurred in CFD trading may be offset against future profits for tax purposes, whereas losses in spread betting are gone for good.”

Whether this represents an advantage to you depends on whether the ability to create and use a capital gains tax loss matters to an investor or not. If it does (if you are using the product as a hedge for example and may even be expecting to lose money on the hedge leg of a trade, you probably want CFDs. But for most speculators spreadbets may be the better bet (excuse the pun!). The mechanics of spread bets and CFDs are similar although the charging structure is different. Spread bets usually include interest within the bid/offer spread whereas with a CFD its more transparent.

In financial spread betting, trades are always denominated in your local currency (pounds sterling in the UK). This is an important distinction. With financial spread betting you are using a stake denominated in pounds, so if you buy Apple stock in a spread bet you are not exposed to any change in value of the dollar. This is not so with CFDs which are traded in their native currency. So in the case of trading CFDs on shares quoted on the USA stock exchange, not only will you have to consider the rises and falls of that particular stock or share but you also have to keep in mind the changes in exchange rate between sterling and the dollar. Let’s take Apple stock for instance. With contracts for differences your gain or loss is not only determined by the fluctuation of Apple’s stock price, but by the rise and fall of the USA dollar. Now, granted this can work in the speculator’s favour, but be warned, it can also reduce gains or increase losses.

Spread betting daily contracts are great for taking out short-term trades while the futures are more appropriate for those far months and of course everything is tax free. If you make £50k you get to keep every penny. Having said this, if you lose money while using spread betting, you cannot off set these losses against other capital gains as you could with physical share trading. Spread betting comes with its own advantages and disadvantages.

New and experienced traders

There are many more Spread Bet providers than there are providers of Contracts for Difference (CFDs). The market for the former is bigger and competition is fierce. Quite simply more traders deal in spread bets in the United Kingdom than deal in CFDs, futures or forex (probably combined). In the UK last year, leveraged trading of stocks accounted for over half of all transactions; and that does not include all the volumes that were internalised by the market maker and never saw an exchange. The increasingly competitive nature of the market means that there are some cracking offers around which may not be available to CFD traders.

Spread Betting is ideal for complete beginners as it’s simple to understand and opening an account is quick and easy. CFDs are sometimes regarded as a more sophisticated product and are aimed at more experienced traders / investors – albeit in practice there is not that much difference between the two.

Key pros and cons of each

Under current U.K. law, neither product is liable for Income Tax, but profits made via CFDs are subject to Capital Gains Tax. Spreads are usually wider on spread bets than they are on CFDs, but spreadbets are commission free, whereas CFDs traders (usually) pay commission. The Long Answer about ‘Spread Betting Vs CFDs’ lists all the things that the two have in common and then highlights their main differences and respective pros and cons.