Spread betting guideline (PDF)
Spread betting with leverage is a very popular kind of betting. It is used by traders or investors to bet on the result of an event. To clarify more, they speculate on whether the price of a financial instrument will increase or decrease with spread bets. Moreover, spread betting is like the CFDs trading. As it is a type of derivative that trades in the OTC market. Besides, you can trade spread betting on any financial markets, such as currencies, shares, commodities, indices, etc. In this course, we will define what spread betting is, how it works, what is its components, and its benefits and drawbacks.
What is spread betting ?
Spread betting with leverage is a derivative product which means that traders do not actually hold the underlying instrument, they just speculate on it. It represents in setting a bet on the price action of an instrument. Moreover, spread betting traders employ the price offered by a broker, then speculate on whether the price will grow or drop. Indeed there are two prices. the bid price which represents the sell price and the ask price which represents the buy price. The difference between these prices called the spread. And the broker will profit from this spread. As it is a derivative product, traders can go in two directions. Whether short or long. Also can take advantage of financial leverage to boost the trade exposure.
Besides, spread being is a tax-efficient method to speculate on the price of major financial instruments. Most traders use spread betting because they can trade whenever they want, when the market is dropping as well as growing. Furthermore, others employ them to diversify, as the spread betting work on any type of market.
How does spread betting work ?
Spread betting is a strategy that works by following the value of the underlying instrument, so traders who want to trade this product can take a position on the market price. If you want to spread bet you need to understand the following concepts:
Buy and sell positions
If you put a bet that the market price of the underlying instrument will rise in price, this means that you might open a long position (buy). Contrary, if you put a bet that the market price will drop, then you might open a short position (sell). On one hand, when the price moves in your favor mean in your chosen direction, then you will make a profit. On the other hand, if it moves against you you will make loss.
For instance, you assumed that the price of silver was going to rise, you can open a spread betting to buy. However, the gain and loss depend on the degree of your assumption was correct. Therefore, if the market rises, then you will profit from your spread bet. But if the price of silver, which is against your assumptions, then you will make a loss in your position.
When trading spread betting you only need to put a small amount of money at the initiation to open a position. for this, we say the expression”trading on margin” to this leveraged product. There are 2 kinds of margins you have to consider when spread betting:
Deposit margin: represents the initial budget required to open a buy or sell position. This budget is typically provided as a percentage of your total trade.
Maintenance margin: Represents the additional budgets that you must pay if your open position begins to register losses which no more covered by the initial budget. If this happens you will receive a notification asking you to increase the budget or you have risk closing your position.
Note: the margin rate depends on the market you trade.
Leverage allows you to expose to the full market for just a bit of market cost. This means that you put down a small amount to control the whole market.
For instance, we say you want to open a position in USD, in the normal case you have to pay the full cost upfront. But if you spread bet on USD instead you have only to pay an amount of money worth 3.33% of the cost.
keep in mind that leverage magnifies your profits and losses, so you need to be careful and put a strict forex risk management strategy.
Spread betting components
As we said earlier the spread is the difference between the bid and ask prices. However, the spread generates the broker’s commission, as the ask price will be a bit higher and the bid price will be a bit lower than the market price. Therefore, the spread will cover all the costs of the trade. For instance, the underlying price of NZD/ JPY is trading at 83.820 and has a 1 pip spread, which indicates that the ask price will be 0.5 points above its current underlying market price and the bid price will be 0.5 points lower. So the ask price will be 83.825 and the bid price will be 83.815.
The bet duration represents the period of time before your position expires. There is a fixed timescale for all the spread betting that can fluctuate between a day to several months. Moreover, you are free to close them at any time before the selected expiry date.
The bet size represents the amount that the trader wants to bet. You choose a bet size that helps you to determine the number of pounds or pennies per point to give to each trade. This will specify how much your profit and loss will be for every point that the market moves. For instance, you bet £3 per point that the instrument will rise. Then for every point, the instrument goes up, you will earn £3 in your position. If it falls, then you will lose £3 in your position.
What are the benefits of spread betting ?
- Spread betting is tax-efficient, you do not have to pay any stamp duty.
- There is no commission charge you have to pay when trading spread betting. Because the profit of spread betting companies comes from the spread they offer.
- Spread betting is a leveraged product so you put down a small amount of money while controlling a large value trade. This indicates that potential profits are magnified as well as your losses.
- You can access 24h markets.
- In the UK spread bettings are tax-free.
- You can trade them in any market over the world (forex, commodities, shares, stocks..).
- You can trade them on both rising and falling markets.
Spread betting drawbacks
While spread bettings have a lot of benefits, they have also some drawbacks which are as follows:
During volatility periods, spread betting companies might widen their spreads. As a result, this can trigger the stop-loss orders in the market, and can rise trading costs. But traders should be careful about setting orders immediately before announcing company earnings and economic statements.
When spread bet traders should be aware of the size of the position they take. Because when taking a position that is too large compared to their account, can lead to margin calls. Therefore, traders should risk only a small part of their capital to avoid falling into this situation. The margin call comes in form of a notification that asks you that you have to top up your funds or you risk closing your position.
Spread betting trading examplesSay that Apple was trading with a bid price of 12060 ($120.60) and an offer price of 12070 ($120.70). Therefore the spread is 10. Let’s suppose that you opened a long position at $10 per point because you believed that the price of Apple will rise.
Winning spread betting:In case your assumptions are correct and the price rise to 12085 /12095. You choose to close your position by selling at 12085 (the present offer price). The price has increased by 25 points (12085 – 12060). This means that the market moved in your favor. Multiply this by $10 (which represents your stake) to obtain your profit. Profit = 25 × 10 = $250
Losing spread betting
If your assumptions are wrong and the price falls to 12035 / 12045. You think that the price will continue falling, Thus to limit your losses, you choose to sell at 12035 (present offer price). This means the market moved against you. Multiply this by $10 to obtain your loss. Loss = 25 × 10 = $250
Spread betting is a derivative product that aims to bet on the price of a financial instrument. However, traders speculate on whether the price of the underlying instrument will go up or down. Spread betting companies make profits from the spread they offer. Moreover, it allows traders to go short or long according to their predictions.