Financial Spread betting sits firmly in the ‘speculative’ realm of investment, but with an understanding of stocks, commodities and indices, the wise investor can take advantage of the significant benefits that spread betting has over traditional investments, not least, protecting money from the tax man. Read on to find out more.

Financial Spread betting is one of the most complex types of betting available. Full of jargon and often displayed in a confused blur of reds and blues, it shares very little with any of the traditional gambling methods. All this is also against the backdrop of a bet where the initial stake is only a small portion of what could actually be lost by the bettor – and it becomes obvious why many people would steer clear of financial spread betting.

But as with many subjects in the world of gambling, a small amount of research and diligence will reveal some major benefits to having a portfolio of spread bet investments.

What is Financial Spread Betting?

A spread bet is not a normal ‘binary’ bet, e.g. win/lose or Yes/No. While it is true that a spread bet will either yield a profit or a loss, it is not as clear cut as a traditional bet. The reason for this is ‘the spread’, and it’s fluid nature.

The spread will mirror an actual figure, be it a stock market value, a currency value or commodity price, ‘the spread’ will move alongside that figure. In order for the spread betting firms to make a profit, this spread will fall just above, and just below the actual price. As an example, a share in Vodafone may be priced at 168p – the spread is likely to sit at around 167-169p. Should Vodafone rise to 172p on the actual ‘real world’ market, so will the spread, to 171-173p.

If an investor thought this upward trend would continue, he could ‘buy’ Vodafone. When buying (also referred to as ‘going long’) the price paid will be the higher end of the spread. In our earlier example, 173p. If the investor suddenly got cold feet and closed his bet immediately, with no change in the price (or spread), he would ‘Sell’ at the lower end of the spread;171p.

If our investor bought at 173p, but sold at 171p, then he has lost 2 ‘points’. The concept of ‘points’ is an important one, because it can be a source of confusion when describing points rather than pennies or pounds. When talking in terms of spread betting, the difference between two figures is always referred to in points. This is because not every market has an underlying monetary value. For example, a bet can be struck on the FTSE all-share index, at 5575. That is purely a number or an indices, not a monetary value. A rise of 15 to 5590, represents a rise of 15 points – not pence, and not pounds.

So our investor lost 2 points on his bet. We need to establish the stake to calculate his loss. Most spread betting firms have a minimum level of £1 per point, although some offer introductory levels as low as 10p per point when accounts are first opened. We will assume our investor was full of confidence in Vodafone and staked £10. His overall loss would be £20 (2 points x £10 stake).

This short example shows how the initial stake does not limit the total amount that can be lost. Had Vodafone announced a profit warning and dropped 35 points, our investor would be £350 down on a single bet.

Leverage or Gearing

Having seen an example of a spread bet, we now come to one of the big benefits – and risks – of spread betting. We have already seen that an investor can lose considerably more than the initial stake, and the concept of leverage increases the risk further.

Leverage, or ‘gearing’, simply allows an investor to put up a small deposit for a position that is worth considerably more. We will run through another example. Our investor returns and wants to buy BP at 416p. If he wanted to buy 100 shares via a traditional broker, with commission and stamp duty, the deal might cost somewhere near £430. With spread betting firms, a buy at a level of £1 per point is the equivalent to owning 100 shares – but the deposit required could be as low as 5%, so our investor would require a deposit of around £21. So the total value of the investment is still £416, but the deposit required on the account is just £21.

This leverage makes spread betting an extremely attractive investing option. But remember that the exposure remains the same – if BP shot up in value by 100 points, the bet will win 100 times the stake level; £100. So while the deposit is low, the profits (or losses) are exactly the same as they would be if 100 shares had been purchased. Deposit levels, and therefore the leverage available, will vary with each market, and each individual stock or index – and it will also vary depending on the betting firm used.

Financial Spread Betting Benefits

As explained, leverage is one of the main draws of financial spread betting. Low deposits mean that an investor can take positions with a value far in excess of their initial stake. There are however, numerous other benefits to these investment instruments.

Tax is one area where spreads gain a massive advantage. Financial bets are treated as any other bet, and no tax is payable on any of the profits. This becomes even more attractive for higher rate tax payers who would be liable for both income tax on dividends, and capital gains tax on any price rise, were they to purchase shares via traditional brokers.

A traditional stock broker would charge commission and levy stamp duty on any trade. These fees are not payable with a spread bet. The only ‘cost’ an investor will face, is the spread itself, that initial difference needs to be made up before any profit can be taken, but with firms competing for business, spreads are becoming tighter and tighter. This removal of trading costs suits the smaller investor who does not want to see fees eating into any profits.

The ability to ‘sell’ (or go short) on a stock is also a fairly unique option for spread bettors. The concept of ‘selling’ an asset that is not actually owned is an odd one, but when betting on the financials it becomes easier to understand – it is simply a bet on the price falling. This makes this type of bet particularly valuable during times of uncertainty or when looking to ‘hedge’ (reduce the risk of) other investments.

While financial spread betting is high risk, it can also be high reward, and investors should certainly consider having a spread betting portfolio.

In future articles we will explore the best firms to open financial spread betting accounts with, and also explain some of the jargon used, such as Stop loss, limits and open orders. We will also look at the different spreads available and how the expiry dates affect the spread.