Spread Betting Explained
Spread betting is a tool that enables traders to profit from both up and down moves on a wide variety of financial markets, whether indices, individual shares or commodities, such as gold or crude oil. What differentiates spread betting from other types of financial speculation is that ALL profits are free of Capital Gains Tax. (under current tax laws) as this is classed a “bet”.
Spread betting differs from fixed odds betting in that; you don’t risk a certain amount per bet, and there is no fixed profit or loss. For example the high street bookmaker may well offer you 5-1 on a certain horse, if you place £1 at those odds and win, you’ll receive £5 profit (plus your stake back). If the bet loses then all you will have lost is the £1 stake.
But the profit and loss on a financial spread bet is always open because you’re betting a stake, usually Pounds per point, on the direction of the market. For example, you may well be expecting the FTSE 100 index to rise and so decide to buy it at £2 a point using a spread bet. If you bought the FTSE 100 index at 4950 risking £2 a point and then sold it when it rallied 50 points to 5000, your profit would be £100 (50 points x £2).
But if the index moved lower and you subsequently sold your bet at 4925 to take a loss, then you’d lose £50 (-25 points x £2). And this is the difference between fixed odds betting and spread betting, your ultimate profit and loss with this style of betting is never known until you liquidate the bet.
Using spread bets a trader can also bet on a downward market by what is called selling short. If you were bearish towards the FTSE 100 expecting lower prices in the future, then you could sell the index short at say the current market price of 4950, and then cover this bet or buy it back at 4900.
If your stake was £2 a point then your profit would be a tax-free £100 (50 points x £2). Of course your view may well be incorrect and the FTSE 100 rises, and so you decide to take your loss by buying back your down-bet or short trade at 5000, so losing 50 points multiplied by your £2 stake, a loss of £100.
Spread betting is very flexible and spread betting providers offer many markets and products to trade, all following the same principle of betting pounds per point. A further advantage to spread betting is that there are no commissions, as the commission is built into the spread.
- Current market on FTSE 100 spread bet : 4946 – 4950.
- If you wanted to go long (or bet on potential higher prices) the FTSE 100 index then you would be a buyer of the spread on the offer price of 4950.
- You would simply state the amount per point that you wanted to go long, for example £2 a point.
- The order would therefore be ‘buy £2 of the FTSE 100 index at 4950′.
- In the above example if you bought £1 of the FTSE 100 at 4950 and wanted to take either your profit or loss you would contact your spread betting broker to get a quote on where the market is, perhaps 4980 – 4984. The market has clearly risen so in order to take your profit you would now sell on the bid price, or 4980.
- The profit earned on this example would therefore be the difference between where you bought the index (4950) and where you sold (4980) multiplied by your stake of £2 a point. Total profit is therefore 30 points or £60.
- But what happens if you got it wrong and the index fell? In order to get out of the trade you’d still have to sell at the broker’s bid price with him quoting a spread of perhaps 4920 – 4924. So by selling at 4920 your loss would be 30 points multiplied by your £2 stake, or £60.
- In order to go short the market or bet on a downward move in prices you will be initiating the trade on the spread bet brokers bid price. If the spread betting company is quoting a price on the FTSE 100 at 4950-4954, you would be selling at 4950. For this example assume that you sold short £2 at 4950.
- Your bearish spread bet on the FTSE 100 was correct and the market moved lower with the spread betting broker now quoting 4926-4930. In order to take your profit you would have to buy at the offer price of 4930, therefore earning a profit of 4950 – 4930 = 20 points x £2 = £40.
- But if you were wrong and the market rallied higher the spread bet broker may well quote 4996-5000, and so again in order to cover the bet and take the loss you would be buying at the offer price of 5000, thus losing 50 points multiplied by your stake of £2, or £100.