What Is Spread Betting?
Among the many opportunities to trade, hedge or speculate in the financial markets, spread betting appeals to those who have substantial expertise in identifying price moves and who are adept in profiting from speculation. One thing should be made clear: spread betting is illegal in the United States. That said, it's still a legal and popular practice in some European countries, particularly in the United Kingdom. For this reason, all examples quoted in the following strategies are cited in British pounds or GBP (£).
Spread betting comes with high risks but also offers high-profit potential. Other features include zero taxes, high leverage, and wide-ranging bid-ask spreads. If spread betting is legal in your market, here are few strategies you could follow.
Technical Analysis Strategies
Popular betting firms like U.K.-based CityIndex allow spread betting across thousands of different global markets. Users can spread bet on assets like stocks, indices, forex, commodities, metals, bonds, options, interest rates, and market sectors. To do so, bettors often apply trend following, trend reversal, breakout trading and momentum trading strategies for various instruments, and across various asset classes.
Spread Betting Around Corporate Actions
Corporate moves can trigger a round of spread betting. For example, take when a stock declares a dividend and the dividend subsequently goes ex (meaning to expire on the declared ex-date). Successful bettors keep a close watch on particular companies' annual general meetings (AGM) to try and get the jump on any potential dividend announcements, or other critical corporate news.
Say a company whose stock is currently trading at £60 declares a dividend of £1. The share price starts to rise up to the level of the dividend: in this case, somewhere around £61. Before the announcement, spread bettors take positions intended to gain from such sudden jumps. For example, say a trader enters a long-bet position of 1,000 shares at £60, with a £5 per point move. So in our example, with the £1 price increase upon the dividend announcement, the trader gains £5,000 (£1 * 1,000 shares * £5 = £5,000).
Similarly, bettors will seek to take advantage of the dividend's ex-date. Assume that one day before the ex-date, the stock price stands at £63. A trader may take a short position of 1,000 shares with a £10 spread bet per point. The next day, when the dividend goes ex, the share price typically falls by the (now-expired) dividend amount of £1, landing around £62. The trader will close his position by pocketing the difference: in this case, a £10,000 profit (£1 * 1,000 shares * £10 per point).
Experienced bettors additionally mix spread betting with some stock trading. So, for instance, they may additionally take a long position in the stock and collect the cash dividend by holding it beyond the ex-date. This will allow them to hedge between their two positions, as well as gain a bit of income through the actual dividend.
Structuring Entry and Exit
Structuring trades to balance profit-and-loss levels is an effective strategy for spread betting, even if the odds aren't often in your favor.
Say that on average, a hypothetical trader named Mike wins four spread bets out of five, with an 80% win rate. Meanwhile, a second hypothetical trader, Paul, wins two spread bets out of five, for a 40% win rate. Who's the more successful trader? The answer seems to be Mike, but that might not be the case. Structuring your bets with favorable profit levels can be a game-changer.
In this example, say that Mike has taken the position of receiving £5 per winning bet and losing £25 per losing bet. Here, even with an 80% win rate, Mike's profits are wiped out by the £25 he had to pay on his one bad bet (0.8*£5 –0.2*£25 = –£1 loss). By contrast, say Paul earns £25 per winning bet and only drops £5 per losing bet. Even with his 40% win rate, Paul still makes a £7 profit (0.4*£25 –0.6*£5). He winds up the winning trader despite losing 60% of the time.
Spread betting often concerns the price moves of an underlying asset, such as a market index. If you bet £100 per point move, an index that moves 10 points can generate a quick profit of £1,000, though a shift in the opposite direction means a loss of a similar magnitude. Active spread bettors (like news traders) often choose assets that are highly sensitive to news items and place bets according to a structured trading plan. For example, news about a nation's central bank making an interest-rate change will quickly reverberate through bonds, stock indices, and other assets. Another ideal example is a listed company awaiting the results of a major project bidding. Whether the company wins or loses the bid means a stock price swing in either direction, with spread bettors taking positions along both outcomes.
Arbitrage opportunities are rare in spread betting, but traders can find a few in some illiquid instruments. For example, say a lowly tracked index is currently at value 205. One spread-betting firm is offering a bid-ask spread of 200-210 for the closing price, while another offers a 190-195 spread. So a trader can go short with the first firm at 200 and long with the other at 195, each with £20 per point.
- Scenario 1: Index closes at 215. She loses 15 (200-215) on her short position but gains 20 (215-195) on her long position.
- Scenario 2: Index closes at 201. She loses one (200-201) on her short position but gains six (201-195) on her long position.
- Scenario 3: Index closes at 185. She gains 15 (200-185) on her short position but loses 10 (185-195) on her long position.
In each case, she still gets a profit of £250, as she nets five points, at £20 per point. However, such arbitrage opportunities are rare and depend on spread bettors detecting a pricing anomaly in multiple spread betting firms and then acting in a timely manner before the spreads align.
The Bottom Line
The high profit potential of spread betting is matched by its serious risks: the move of just a few points means a significant profit or loss. Traders should only attempt spread betting after they've gained sufficient market experience, know the right assets to choose and have perfected their timing.