What is Spread Betting
Spread betting is a type of speculation that involves taking a bet on the price movement of a security. A spread betting company quotes two prices, the bid and offer 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 offer. The investor does not own the underlying security in spread betting, they simply speculate on its price movement.
BREAKING DOWN 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. 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?)
Spread Betting Example
Let’s assume that a spread-betting company quotes a bid of $200 and an offer of $203 for ABC stock. The investor is bearish and believes that ABC is going to fall below $200. He or she decides to wager $20 for every point the stock falls below $200 and executes the trade (bet). If ABC falls to $190, the investor makes a profit of $200 ($20 x $10). If the price rises to $215, he or she loses $300 ($20 x $15). The spread betting firm requires a 20% margin, which means the investor needs to deposit $800 (20% x position value of $4,000) into his or her 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 losses and increase trading costs. To avoid widening spreads, investors should avoid placing orders immediately before company earnings announcements and economic reports.
(For further reading, see: Understanding Financial Spread Betting.)