How does spread betting works?

Spread betting is appealing to many people, as it is easy to understand and offers you the possibility to multiply your money when you correctly predict an outcome. It is truly betting, and you can even spread bet on sporting events, even though it is frequently based on the financial markets, the context that we consider here. Having said that, it is regulated by the Financial Conduct Authority (FCA) rather than the Gambling Commission.

The way spread betting works is simple. You can take a bet on the movement of a price (or a score for the sporting version), and if you are right you profit. Unlike regular betting, you do not have fixed odds set by the bookmaker and just win or lose, but you are paid according to how far the price moves.

You bet a certain amount for each point that the price moves, and this determines how much you win. If you lose, you have to pay the same amount per point out to the bookmaker, so there is the possibility of losing quickly too. The name spread betting comes from the spread, which is where the bookmaker earns his income. The spread is the difference between the price you can buy at and the price you can sell at, and is best explained with an example.

You incur (if long) or receive (if short) financing fees for rolling contract overnight on a daily basis. Additional margin payments may be applicable at the discretion of the spread betting provider if the open trade moves sharply into loss-making territory.

“Spreadbets provide a simple way for private traders to increase their profit potential. The purchase of a traditional share purchase requires the full amount of the market exposure to paid for upfront and in full (10,000 shares of company A at 100p, requires full £10,000 deposit outlay). With a spread bet, however, the initial outlay for an identical trade could be as low as £500.”.
The reason for this difference in initial deposits lies in spread bets requiring only a deposit (as low as 5% for shares) for the spread trade to be placed. Whilst the initial capital outlay is lower the risk/reward remains the same as if £10,000 of physical shares were being held. The spread trader benefits/suffers to the same extent as the traditional shareholder but benefits from not having to part with the full amount at the outset.”

Workings of Spread Betting

The purpose of a spread should be fairly self explanatory. It is simply the prices that the market maker publishes that you can buy and sell at, much the same as the price you can buy and sell your currency at when you get to the airport to go on holiday.

Long Positions

If you believe the share (or index, commodity or other asset) will go up, you buy at the offer price (the higher of the two prices).

Short Positions

This is a reverse of the above scenario where you are selling at the bid price.

Let’s take a spread betting shares example -:

Take a UK stock like Vodafone, currently trading at 177p per share.

The way the spread bet works is that the spread betting provider will make you a market, by publishing a Vodafone spread 176 / 178.

In other words you can buy Vodafone at 178 and sell if at 176.

Now UK stock “tick” in pennies, so a move from 177 to 190 will constitute a 13 point move, but you will be paying a spread both in and out of the trade.

The amount you will wager on the bet is usually set at a minimum of £1 per point, and a maximum is unlimited within reason.

What you have to consider is that the bet is a form of leverage.

So let’s say you believe Vodafone is going to go up from its current market price of 177.

The spread is 176/178, so you buy £10 per point at 178.

Vodafone rises to 190, and you decide to sell.

The spread at 190 is 189/191, so you sell £10 per point at 189, closing your trade and realising your profit of 11 tics, or £110.

Now when you opened your trade buying £10 pp @ 178, the company will have required you to place a deposit on the trade (or initial margin). Typically for a FTSE 100 stock it would be about 10% of the notional value, so in this case £178.

Now remembering that UK stocks tick in pennies, your £10 per point bet has a real world equivalent of buying 1000 shares of the stock:

i.e. £10 per point move on 178 points = £1,780
1000 shares at £1.78 = £1,780

The key is the leverage. If you had gone to a traditional stockbroker and asked to buy 1000 shares of Vodafone, you would have been required to post the full value of the stock, AND pay the stockbroker a commission. The spread bet has the same effect, but you only require 10% of the value to have the same exposure to the stock move, and pay no commission.

That, and the fact that spread betting is tax free, including capital gains.

Remember that the bet is just that. A synthetic product that allows you exposure to the movement of the stock, but offering leverage, and a tax benefit.

Of course the point is that your losses when spread betting can outweigh the initial deposit, where if you are buying a stock, they cannot.

That’s a pretty simple guide, but it applies to anything, whether you are spread betting on the number of runs in cricket, the voter turnout at the next election etc

When spread betting, do I own the underlying asset?

No. Financial spread bets are derivatives, based on the price of other assets. Athough the spreadbets are based and quoted on assets that are traded on recognised exchanges, when spread betting you are only speculating on the movement of a financial instrument – without actually ever owning the asset. Because of this, unlike traditional stock broking, you can benefit from both rising and falling markets and are not required to own the underlying asset.

“Some people tend to think that spread betting is too complex when compared to shares dealing but this is wrong. On a risk-reward perspective, a £1500 share investment is the same as a £15-per-point spread bet on a stock priced at 100p. If you make a £30-per-point spread bet this is equivalent to holding 3000 shares (to get the equivalent in shares simply add two zeros to your stake)”.
However, if you wanted to buy 3000 shares priced at 100p each you don’t need to deposit the full £3000 with a spread betting broker. The financial spread betting provider might ask you for a 10% margin payment which in this case would be £300″

Dow Jones Spread Bet Example

Suppose you wanted to spread bet on the Dow Jones Industrial Average (DJIA). You might be quoted 10,500/10,530 by your dealer. This means that you can buy, which is essentially taking a long position, at 10,530. If you thought that the Dow was going down, and wanted a short position, you could take that at 10,500. The actual DJIA is somewhere between these two numbers. You can name your stake, which might be £1 per point.

If the Dow goes up 100, to 10,600/10,630, and you have a long position which you took at 10,530, you could sell at 10,600 for a 70 point gain, which would give you £70 profit. If you had taken a short position, however, you would lose 130 points, from 10,500 to 10,630, and have to pay the bookmaker £130. The spread ensures that the winners get less than the losers lose, and that’s how the bookies stay in business. When you choose where to bet, you need to examine the spreads offered and choose the lowest ones.

FTSE 100 Spread Bet Example

Let’s now consider a spread bet on the FTSE 100. Suppose the FTSE 100 cash index is currently trading at 5000.5, the quote for the FTSE 100 index could be, say, 5000.0-5001.0 and you are of the opinion that the FTSE 100 will continue rising in value, therefore you buy for £2 per point at 5001.0. A few hours later, the FTSE 100 index has risen to 5021.5 and the spread betting quote is now 5021.0-5022.0. You decide to close your trade and to do this you sell £2 at 5021.0, giving you a net profit of £40 (this is the number of points between your opening and closing level, multiplied by your stake).

However, if you had sold the spread betting provider’s quote at 5000.0 for £2 per point in the anticipation of the FTSE 100 falling in value and subsequently closed at the new price of 5022.0, you would have lost £44.

Do realise that you can make quick gains spread betting but you can also accumulate substantial losses quickly if you aren’t careful. As a result, you need to have money in your account before you can open a trade. This money is referred to as margin, and each market has a different margin requirement.

To make money spread betting, you should approach it as a business and study trading in the market you want to bet on. You have a choice of most financial markets, including currencies and commodities, and you should pick one that you know about or want to learn about. You must learn good trading principles, otherwise your bet will just be a gamble. In particular, you need to minimize your losses by exiting bets quickly if they turn against you, as the losses can mount up quickly.

Finally, when you make profits from spread betting the good news is that, in the UK at least, you do not need to pay capital gains tax on them. The government regards your winnings as a prize, and not as the profit from an investment.

“Financial spread betting takes a number of forms. Day, rolling, monthly and quarterly contracts all lend themselves to certain traders and particular trading strategies better than others. The suitability of each spreadbet type depends on the trading timeframe you intend to hold onto a position. The normal holding period could be anything from a few hours up to a few days, although it is sometimes possible to run trading positions for longer. All things equal though, spread betting is generally seen as more suitable for shorter-term traders than their longer-term equivalents.”