What is a Spread Bet?
Spread betting allows traders to speculate on the movement of market prices and can include asset types such as indices, commodities, shares, currencies, and others. Ownership of any specific asset is not necessary since spread betting is a derivative product and derives its value from the behavior of a base asset.
Similar to other trading types an investor either decides to go long or go short in a trade, that is to buy or sell. If the trader believes the price of a specific asset will rise then, they will go long similar to CFD trading. The difference between trading CFDs and Spread Betting is that the CFD is entered into at an overall value such as 1000 shares at 10p per share.
Any increments above or below the share price are multiplied by the number of shares to calculate the profit or loss. So if the trade was to go long and the price increased to 12p per share, they would be ‘in the money’ to the tune of £20. With Spread Betting the speculation must be made with a virtual wager per point rise or fall. If a trader were to go long in spread betting at £100 per point in the above price example, then the 2p increase would be simply multiplied by the wager amount of £100=£200 profit.
What is the Spread?
One could say that the spread is how the brokers earn their living. Each spread bet will have a BID and ASK price or BUY and SELL. The difference between the BID and ASK price is known as the Spread. For example, a BID price for a specific share may be 101p and the ASK (SELL) price 99p. The actual price of the underlying asset will probably, in this example, be 100p. This means that the spread is 2p. In real terms, this means that to go long and profit would need the share price to pass 101p for the trader to pass a break-even point. This effectively means that the house (or broker) keeps the first point profit as a type of commission.
Leverage in Spread Betting
Spread betting is a leveraged product which means that a trader is only required to pay a small margin or deposit to place a trade of a much larger value. Different brokers charge different amounts for different types of derivative trades but a fairly typical margin for Spread Betting is around 5%.
This is a huge plus because in traditional share dealing a trader would need to invest the full value of the share allocation to achieve often comparably tiny profits. For example, a trader in a traditional share dealing transaction would pay £1000 for 100 shares @ £10. If they sold at £12, the profit would be £200 but for an investment of £1000 plus commission and taxes. To achieve £200 in Spread Betting on the same asset would be calculated as follows:
A trader would go long @ £1 per point. The BID price, for simplicity, will be 1000p or £10 and the rise to £12 or 1200p would equate to a 200 point rise @ £1 per point = £200.
The margin required is calculated as £1/point x PRICE (1000) x 5% = £50. In this example, we left out the spread price which would have left us with £199 in reality but the principle is the same, and the amount required as a deposit is trivial compared with the previous share trading example where the full amount plus commission and taxes would be required.
Stamp Duty Exempt and Commission Free
Spread Betting in the UK is free from Capital Gains Tax which is a big saving compared to other types of trading. As a derivative financial product, it is also exempt from Stamp Duty in the UK. Please be aware that tax laws in the UK can change at any moment and individuals may be treated differently depending on their circumstances. Keeping abreast of relevant changes in tax and trading laws is an essential part of being a successful trader.
Spread Betting is commission free so that no matter how high returns are, it is only the spread price that is payable to the broker. Traders should always be aware that leveraged products offer the same risks of losing large amounts of money as they do the prospects of gaining.