What is spread betting and what advantages does it offer?

Spread betting is one of the most effective ways to try and take advantage of moves in a whole host of financial markets. Whether you want to trade individual shares; indices like the FTSE 100; forex pairs like the pound/US dollar rate or commodities such as gold and oil, you can do this using spread betting. The spread betting companies make a market price, wrapped around where the underlying market is trading.

This is the spread and for popularly traded markets this is usually very tight.  So, with the FTSE 100 for example, the spread bet price may be 7200/7201. If you think the FTSE 100 is going to rise you would ‘buy’ at the higher price,  7201 in this case. You would buy so many pounds per point, let’s use £2 in this example. There is no additional commission to pay when spread betting, the company’s profit is tied up in the market’s spread.

Let’s say you are right and the FTSE rises, the spread bet price will track the market higher. When the market is trading at 7221/7222 you decide to take your profits so sell at 7221. You bought £2 per point at 7201 and closed the position at 7221. The market moved 20 points in your favour, so with a £2 per point trade you will have realised £40 profit. If the market had dropped 20 points and you decided to get out, you would have realised a loss of £40. It is completely up to you when you close out your spread bet - the market moves in real time and many markets these days are tradeable 24 hours of the day.

You are not just restricted to trying to profit just if markets are rising. If you think the price is going to drop you can ‘sell short’ using spread betting. Using the example above on the FTSE, if you thought it was going to slide from 7200/7201, you could have sold £2 per point at 7200 to open up your trade. Every point the market dropped below your entry point would be a £2 profit - you are making money from the market sliding.

And, if you are a UK taxpayer, with the usual caveat that tax laws can change, any profits from spread betting are exempt from capital gains and income tax.

How can I use it as part of my investing strategy? 

Although the popular image of financial trading is of someone glued to a screen full of prices and charts, trying to second guess which way a whole host of markets are going to move in the next few seconds, you don’t have to trade this way. You are free to choose your own time frame. There are plenty of people using spread betting as an alternative way of investing in the short to medium term. Let’s say you had a view on a share price over the next few months. You could buy the share through a stockbroker as usual but spread betting can be a real alternative to this.

If you bought £10 per point of, for example, the Marks & Spencer spread bet, it is the equivalent of owning 1,000 shares in the company. For every point (or penny, in the case of spread bets on shares) that the market moves in your favour it represents £10 of profit and vice versa if the price drops. But with spread betting there is no commission to pay, no stamp duty and again any gains are tax free. On top of this, spread betting uses leverage - this simply means you do not have to put up the full cost of the trade. There are additional risks with this but, managed sensibly and not overstretching yourself means that spread betting on shares can be a real alternative to using a stock broker - particularly for short to medium term opportunities.

Another way that spread betting can fit into your investment strategy is to use as a hedge - a form of insurance. You may have a portfolio of blue chip shares that you want to hold for the long term but in the short term you feel the market is due to take a dive. You are concerned about the effect this will have on the value of your portfolio. You could sell an index such as the FTSE 100, FTSE 250 etc. using spread betting to set up a hedge. This way, if the market slides then what you lose on your holding of physical shares can be partly offset by what you make on your short spread bet.

If the market rises then you will be losing on your spread bet hedge but achieving a return on your portfolio. It’s just another way that spread betting can be used in addition to straightforward directional trading.

What are the most popular trades and markets?

Many people start spread betting on markets they may feel they have some familiarity with, or have experienced in the past, possibly from an investing point of view. For example, plenty of us are aware of the UK’s blue chip stock market index, the FTSE 100. This is a popular market for clients and the tight spread means the cost of doing business is very low. It is therefore not surprising that people casts their net a little further afield and start trading the US market - the Dow Jones is always a popular one. There are a couple of reasons for this. The US stock market tends to dictate the direction of the rest of the world, which means it is always an important one to watch. And the trading hours make it attractive. Plenty of people using spread betting have a day job which doesn’t allow them the time to watch the markets. But US shares usually trade until 9pm UK time, so trading can fit around working hours.

It is impossible to ignore the forex or currency markets when it comes to what is popular to spread bet on. There has been an explosion of interest in these areas in recent years. The spreads are tight and these markets are seldom dull. With the UK’s vote to come out of the EU in June, markets such as the pound have seen unprecedented movements (referred to as volatility). Plenty of traders have been backing their judgement on whether there is worse to come in the likes of the euro versus the pound (EUR/GBP) or whether the sell-off has been overdone and it is time for a recovery.

What are the costs and what is a margin requirement?

The first obvious cost with spread betting is the spread - the difference between the price you buy at and the price you sell at. This is a cost in all markets, there is always a two way price for buyers and sellers. Spreads have come down drastically over the years and most companies are now very competitive.

The second cost is what is known as a financing charge if you run a trade overnight. Spread betting uses leverage, in effect you are borrowing part of the money for the trade from your broker. There is a financing charge for this - usually expressed as the bank’s base rate (LIBOR) plus a small percentage. In reality this is a relatively modest cost but can mount up if you run a trade for more than a few months.

Because you are trading on margin and using leverage, you don’t need to put up the whole cost of the trade, just the margin requirement or initial margin deposit. Let’s look at an example. You spread bet on Marks & Spencer buying

£10 per point at 330p. Your total position size is £3,300 (£10 per point x 330). But your spread bet broker only requires a 5% deposit against this position. So in this case your margin requirement is £165. You may need to add more if you incur losses while you are running the trade, which is why most spread bet clients keep a surplus in their account.

It is important to understand that this margin deposit is not a form of commission. When you decide to close the trade completely and realise your profit or loss, that initial margin requirement is freed up once again and is available for other trades.

About IG

IG is a global leader in online trading, providing fast and flexible access to over 10,000 financial markets - including shares, indices, forex, and commodities.

Established in 1974 as the world’s first financial spread betting firm, our aim is to become the default choice for active traders globally. We are an award-winning multi-platform trading company, the world’s No.1 provider of CFDs* and a global leader in forex. We provide our clients with the option of a no-negative guarantee on trading accounts, and we now offer an execution-only share dealing service in the UK, Ireland, Germany, France, Australia, Austria and the Netherlands.

*Based on revenue excluding FX (from published financial statements, October 2016)

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