What is Spread Betting?

Spread betting refers to speculating on the direction of a financial market without actually owning the underlying security. It involves placing a bet on the price movement of a security. A spread betting company quotes two prices, the bid and ask price (also called the spread), and investors bet whether the price of the underlying security will be lower than the bid or higher than the ask. The investor does not own the underlying security in spread betting, they simply speculate on its price movement.

Understanding Spread Betting

Spread betting allows investors to speculate on the price movement of a wide variety of financial instruments, such as stocks, forex, commodities and fixed income securities. In other words, an investor makes a bet based on whether they think the market will rise or fall from the time their bet is accepted. They also get to choose how much they want to risk on their bet. It is promoted as a tax free, commission free activity that allows investors to speculate in both bull and bear markets.

Spread betting is a leveraged product which means investors only need to deposit a small percentage of the position's value. For example, if the value of a position is $50,000 and the margin requirement is 10%, a deposit of just $5,000 is required. This magnifies both gains and losses which means investors can lose more than their initial investment. (To learn more, see: Margin Trading: What is Buying on Margin?)

Key Takeaways

  • Spread betting refers to speculating on the direction of a financial market without actually owning the underlying security.
  • The investor does not own the underlying security in spread betting, they simply speculate on its price movement.
  • It is promoted as a tax free, commission free activity that allows investors to speculate in both bull and bear markets.

Spread Betting Example

Let’s assume that the price of ABC stock is $201.50 and a spread-betting company, with a fixed spread, is quoting the bid/ask at $200 / $203 for investors to transact on it. The investor is bearish and believes that ABC is going to fall below $200 so they hit the bid to sell at $200. They decide to bet $20 for every point the stock falls below their transacted price of $200. If ABC falls to where the bid/ask is $185/$188, the investor can close their trade with a profit of {($200 - $188) * $20 = $240}. If the price rises to $212/$215, and they choose to close their trade, then they will lose {($200 - $215) * $20 = -$300}.

The spread betting firm requires a 20% margin, which means the investor needs to deposit 20% of the value of the position at its inception, {($200 * $20) * 20% = $800, into their account to cover the bet. The position value is derived by multiplying the bet size by the stock’s bid price ($20 x $200 = $4,000).

Spread Betting Benefits

  • Long/Short: Investors have the ability to bet on both rising and falling prices. If an investor is trading physical shares, they have to borrow the stock they intend to short sell which can be time-consuming and costly. Spread betting makes short selling as easy as buying.
  • No commissions: Spread betting companies make money through the spread they offer. There is no separate commission charge which makes it easier for investors to monitor trading costs and work out their position size.
  • Tax Benefits: Spread betting is considered gambling in some jurisdictions, and subsequently any realized gains may not be taxable. Investors who spread bet should keep records and seek the advice of an accountant before completing their taxes.

Limitations of Spread Betting

  • Margin Calls: Investors who don’t understand leverage can take positions that are too large for their account which can result in margin calls. Investors should risk no more than 2% of their investment capital (deposit) on any one trade and always be aware of the position value of the bet they intend to open.
  • Wide spreads: During periods of volatility, spread betting firms may widen their spreads. This can trigger stop loss orders and increase trading costs. Investors should be wary about placing orders immediately before company earnings announcements and economic reports.

      (For further reading, see: Understanding Financial Spread Betting.)