Backing your judgement
Spread betting on sport is a high-profile activity, but reports suggest that companies offering the service now make more money from financial spread betting.
However, care needs to be taken when using spread betting. Although there are potential tax and investment advantages, you can also suffer unlimited losses.
Understanding the basics
You can bet on whether investments will rise or fall in value. The more they rise or fall, the more money you make or lose. You can bet on a wide range of investments, including shares, indices, currencies and commodities, such as gold or oil. This can provide diversification away from your existing portfolio without holding the actual investments, as you are betting on their price movement.
Say you want to bet on the FTSE 100
. If it is currently trading at 6500, a company will quote you a bid (selling) and offer (buying) price. This spread may be 6490 to 6501. If you think the FTSE 100 will rise, you can buy the index at £10 a point. If the FTSE 100 does rise to 6535, you will make £340 (6535 – 6501 = 34 points).
But if the index fell to 6461 then you would lose £400. And you would lose more if the index continued to fall.
A range of options
There are different ways in which you can spread bet. Peter Murphy, director of IG Index, says you can make a daily bet that is closed at the end of that day. You can then contact the spread betting company to roll the bet over to the next day or establish an automatic roll-over until you close the bet.
Rolling over a bet incurs an overnight charge, and if you do it continually, the charges mount up and can eat into any gains. You can also set up bets for longer time periods, the maximum quoted period usually being one year.
You can close your bets at any time before they expire, as well as partially closing them – taking some of the profits the bet has accrued but retaining the bet.
Spread betting firms do not charge commission, but make money from the bid-offer spread. The prices of shares and indices are based on futures markets, which reflect the price of the underlying market plus some adjustments. These adjustments, which are called the ‘fair value’, include an interest charge minus dividends due over the period of the bet.
The spread on the quotes you are given on indices and shares will, therefore, be wider the longer the time period of the bet. Murphy says the spreads are typically around two points on daily bets, six points on quarterly bets and ten points on a yearly bet. This means you have to make a profit of at least ten points to generate a gain on a 12-month bet, but he argues that the FTSE 100 frequently moves up or down by at least 60 or 70 points in just one day.
Rules of the game
Experienced trader Vince Stanzione says there are two main factors that limit the degree of spreads, including the fact that customers can arbitrage between spread betting firms. ‘Customers can go long one provider and short another provider if they have different prices.’ He adds that ‘Firms are also competing with each other and, therefore, they will not let their spreads widen too far.’
So you should check the prices being offered and how these compare to the underlying share prices and indices. You can also take out a ‘good till cancelled’ bet, which is left open until you cancel it.
There are measures available to manage the risks in spread betting. Firms will provide demo accounts for spread betting, so you can try it out without committing any money. Once you start betting, you can use stop-losses – indeed, some firms insist on new customers operating stop-losses. These enable you to nominate the lowest point to which you are willing for an index or share price to fall or the level of losses you will accept.
Murphy points out that you can also nominate an upward price at which you want the bet to be stopped so you can take your profits.
With a traditional, automated stop-loss, if the share price or value of the index falls very quickly, there is a risk that your bet will be closed at a much lower price.
A guaranteed stop-loss, however, acts as an insurance policy. But there are wider spreads within this approach to pay for this guarantee. This means you will have to generate a higher return before making a gain. Nevertheless, guaranteed stop-loss points are very useful if you are risk averse or do not have the time to continually monitor your bet.
Vince Stanzione warns investors not to make the stop-loss point too close to the current trading price, due to normal price fluctuations: ‘You may get home and find the index has risen 200 points but you have not benefited as your stop-loss point was reached in the morning.’
In the margin
The advantages of spread betting can enhance your investment strategy. For example, you may want to diversify your investments but do not have sufficient spare capital. With spread betting, you bet ‘on margin’. This means you do not have to find all the money up front for a bet.
For example, if you want to buy 1,000 shares at £42 each, it would cost you £42,000. With spread betting, you can bet £100 a point, for example, that the price will rise or fall. Typically, you just need to put a deposit down to cover your bets. You can start spread betting with small amounts of money that may not be possible when investing in shares.
You can use spread betting to hedge existing investments. Say you think the banking stocks in your portfolio may fall in value in the short term. Rather than sell the shares and trigger a tax charge, you can bet on their prices falling and thus protect your exposure to this sector.
You could use contracts for difference (see p. 5-6) to benefit from falling share prices. But any profit from spread betting is free of capital gains tax (CGT). And you are not subject to the 0.5 per cent stamp duty that applies to buying shares.
But there is a downside. If options are used to hedge a portfolio, the cost of this hedge can be used to offset the tax on gains from the equities they were being used to hedge. The costs of using spread betting to hedge a portfolio, however, cannot be used to offset any CGT liability.
A sideways look
You can also bet on indices or share prices moving sideways within a specified trading range or on the degree of volatility to be suffered by indices. Plus it provides diversification by providing access to investments, such as currencies, that you may not normally hold in your portfolio.
Financial advisers are, however, cautious about spread betting. Patrick Connolly of Towry Law says clients have to separate it from their investment portfolios: ‘Spread betting is just gambling – it is different from investing. With spread betting, you are trying to predict daily movements in indices and shares, rather than investing money for the long term.’
Spread betting offers the opportunity to make money from rising or falling share prices. But read all the terms and conditions and ensure you understand the full risk before making a bet. After all, the losses can be unlimited.
The principles of spread betting
Experienced trader Vince Stanzione sets out ten key rules to follow if you want to make profitable use of spread betting:
- You can make money in all market conditions
- Start small and build up
- Diversify
- Know your personality and trading style
- Money management is the key to survival
- Cut your losses and let winners run
- Treat financial spread trading as a business
- Don’t get carried away by technology
- The crowd (and the media) are normally wrong
- Don’t feel you must trade all the time.
Vince Stanzione has produced a home study course to teach private investors how to benefit from trading financial spread bets and fixed odds, priced £347. For details, visit www.fintrader.net
