Advantages and Disadvantages of Financial Spread Betting

Advantages of Financial Spread Betting

Easier to understand than other financial instruments - The process is less complex than that for options, futures and contracts for difference.

Tax free winnings - Tax is just another overhead and tax avoidance scheme/s are a welcome and widely accepted practice to increase profits. So eliminating it I have an immediate advantage over somebody who cannot avoid it. This is a key advantage of spread betting in that gains are free of tax (no capital gains or income taxes and no stamp duty). When using a traditional stockbroker, all profits are subject to Capital Gains tax. Moreover, spread bets are free from stamp duty, currently charged at 0.5% on all share purchases. This is because a spread bet is a contract between the client and the spread betting company and no physical exchange of shares actually takes place. The only real tax due on spread betting is a 3% betting tax charged on the firm's gross profits - which is absorbed by the company in the spread.

By itself the stamp duty exemption means that taking spread betting positions on stocks is cheaper than directly buying the underlying stocks for trades held for up to a few weeks, although if held for longer periods the financing charges associated with spread betting will add up. The savings do add up. For a purchase of £5000 of any share, the stamp duty charge paid to the Government is £25. A trader who deals twice a week, 52 weeks a year will end up paying £2,600 in stamp duties alone. If you were to trade £25,000 in normal share transactions each trading day via a stockbroker, you would pay the Government (brother Sam!) more than £31,500 in stamp duty over a year.

Investors Chronicle quotes the case of full-time trader Roy Mitchell: 'On an average trade, Mr Mitchell trades £10,000-worth of Man Group shares in spread betting, for which he pays £68 in commission and £2.25 for every lot that is filled. The latter amount might not sound much, but so far this year he has paid about £3,200 getting his orders filled.' 'In one of the many trades of his favourite share Man Group, he sold the shares at 550p and bought them back at 545.5p, locking in a gross profit of 4.5p, equivalent to £382 after brokerage fees were paid. This profit would only be £110 if he had to pay stamp duty of 0.5 per cent. Mr Mitchell trades spread bets because there is no capital gains tax on the profits, which is not the case for direct share trading and for contracts for difference (CFDs).'

Also, as far as I'm concerned one of the biggest advantages of spread betting is not just that no CGT or income tax is payable - but that I don't have to organize the tax-related records that comes with frequently buying/selling/reducing/increasing real shareholdings.

Potentially massive returns on low investments due to high leverage - The majority of traders already know that some form of leverage must be used if you want to make short term trades and reap any benefit from small movements in price. Low margin requirements normally allow good leverage for larger positions. In most cases only between 7.5% and 10% is required as margin to be deposited with the spread betting firm. A margin of 10% would mean that a 2% in the share price would generate a 20% return. This is called margin trading and is useful for magnifying potential profits on equity, commodity or index positions.

Make phased exits without additional broker fees - One big advantage of using spreadbets rather than actual share purchases, is that one can make phased exits without incurring duplicated or triplicated broker fees. This can have tremendous psychological value. I could for example determine beforehand that I will sell say one third on a 10% price fall, another third at 15% down, and only sell the remainder if the price is 20% down. (Or using 5%,10%,15% or whatever). I can thereby feel that I have been fair to that stock and given it every chance to rebound. Whereas with an actual shareholding the avoidance of multiple brokerage fees means setting a fixed level at which I sell the lot or don't - and that "all or nothing" moment is where many investors get stressed and come unstuck by feeling they really ought to give it "one more day" or whatever, only to then find themselves tipped into a sharp fall that is triggered by other market participants who did sell. There are occasions where I will phase my way into or out of a particular bet in £1pp increments. (£1 per point is the equivalent of buying or selling 100 shares, which is too small an increment to be viable if repeatedly applied to a real shareholding).

It is commission-free - All the costs associated with spread betting are built into the bid-offer spread. In contrast if you go through the traditional broker route you will need to pay your broker twenty pounds a go at least to buy and sell the shares for you. So although traditional share dealing is excellent for someone with a large account who wants to buy and hold, spread betting is much more cost effective for someone who is looking into buying or selling, three, four, five times a day, if you like - even twenty trades a week.

Possible tax savings - For example, if you own a share paying a dividend, income from that dividend is taxable at your current income tax rate. Spread bets do not pay dividends. Instead, the dividend payment is build into the bid-offer spread so the holder of a position in a dividend-paying share will reap the rewards in the form of a tax-free capital gain rather than taxable income.

The ability to trade in amounts less than the standard market contract sizes - With some you even bet with just 1p a point via the Internet.

The ability to trade outside market hours - Most spread betting companies are open 24 hrs a day from Sunday night until Friday night. i.e. in many cases it is possible to deal when the traditional markets are closed. Contrast this with normal market trading hours which run from 8.00 am to 4.30 pm!

Controlled risk bets - A controlled risk bet is one which has a special kind of stop-loss order attached to it. When you open a controlled risk bet you pay a small premium though an increase in the bookmaker's dealing spread, and you choose a stop loss level at which if the bookmaker's quotation reaches it, your bet is to be automatically closed out.

No huge capital outlay required - You can start to trade with as little as £100 on deposit and use as little as 1p to "bet" on the price movement of shares, market indices (such as the FTSE, NASDAQ, Wall Street (Dow Jones), S&P, Nikkei), currencies or commodities (such as gold or oil) Also, there is no different spread quoted for a smaller size bet. Therefore small positions are not penalised like they can be in cash markets.

Credit facilities - Subject to your experience and financial status most spread betting firms will offer you a credit account which eliminates the need to tie up capital.

Immediate dealing - Executions are completed within 1 minute. This is because spread betting companies are not brokers, so all trades are contracts between the client and the spread betting company. Thereby each execution is not necessarily traded over an exchange and there is no delay in routing the order.

No currency risk - Dealing in foreign share can be cumbersome and impractical if you are an average investor. You have to deal with a third party and pay transaction charges. For example, in 2002, traders found it strenous to balance their books in sterling terms because of the ups and downs of the yen and the US dollar. Spread betting allows traders to bet in pounds per point on international shares. This is unlike CFDs where you are trading in the base currency of the market you are trading. For instance with CFDs if you make a Wall Street trade this will be in US dollars so if the Dow rises by 5% but GBP/USD rises by 5% in the same time frame, you would not have made as much as you originally thought.

Get currency conversion rates at favourable rates - One of the most favourable things spread betting and cfd providers can tout is getting currency conversion at very competitive rates. One provider offered me 50bps without even knowing who I were. That's .5% above interbank. In fact it has been reported that some small corporate firms use spread betting to hedge their foreign exchange exposure. Quoting Simon Denham from Capital Spreads 'Some companies find it is actually cheaper to hedge their foreign exchange with us than it is to go through their banks. These firms are below FTSE 250, but they want to do several million pounds a shot'. When a smaller company does a foreign exchange hedge deal, they normally won't get a very good rate from a bank in the first place, and the bank will also expect them to put up 20% of the margin. We only ask them to put up 2-3% initially. Of course, they don't get the tax advantage that private investors do - from their point of view, it is simply a known risk in a foreign contract, so they declare it to the Inland Revenue as a hedge position.' says Capital Spreads' Denham.

Wide range of markets you can bet on - Herein lies one of the main benefits of spreadbetting. They deal on most exchange traded contracts that are liquid as well as some not so liquid ones/less accessible ones like Polish Index, (ATX) Austrian Index, (Bel20) Belgian Index, (OMX30) Swedish Index, taiex, zinc, lead , tin, aluminium, carbon emissions, london housing, currencies, options, interest rates, commodities, football (!), horse racing (!), rugby (!) to how many sips of water the Chancellor Gordon Brown is going to drink during his Budget speech!! Being able to bet on indices is a great advantage because in my opinion it is far easier to see if the tide is going up or down rathering than looking at lots of different boats to put your money into. Most make markets for bets on stocks, stock options and future options as well from major exchanges. Bets are available on many liquid assets including a wide range of quoted shares, and at some spread betting companies this extends down to companies with a market capitalisation as small as £10m.

Spread betting providers also provide you with access to certain far flung markets that it would be quite difficult (if not impossible) for you to do on your own. Try getting a brokerage account in Canada as a non-resident for instance...

Ability to go short or long (i.e. you can make money when markets rise or fall) - Shorting allows you to make money not only in rising markets but also in falling markets. This is key to spread betting, since you do not physically own the share or underlying instrument, but trade solely on the price movement, you can 'bet' on prices moving down as well as up. With stock markets so bearish over the last two years, it has been extremely difficult to make profits as a trader without the ability to go short.

Diversification - The only thing free in investment is diversification. Not exactly true but quite close. By allowing you to bet on an index rather than just a share, you can gain instant balanced explosure to the market.

You don't need to own assets in order to profit from them.

Trade many different markets from just one account - Spread Betting provides people with the ability to trade many different markets from just one account - British shares, American shares, European shares, stock market indices, government bonds, exchange rates, gold, oil, index options, and of course sport and politics.

You can Limit your Losses by placing 'Stops' on your account - stop loss orders can even be 'guaranteed' to be executed at a price you stipulate in advance, in fact a stop loss order set with a spread betting firm does not depend on a physical order being put through the underlying cash market and in this respect execution of stop loss orders is better than with ordinary stock brokers

Less paperwork is involved compared to conventional share dealing. - setting up a spreadbetting account is simple and quick, all that is required in most cases is a signed application and utility bill.

Spread betting makes it easier to track your investments - if share X is up 15 points on the day, it is far easier to estimate your profit by calculating that you have made a £10 per point increase than calculating your number of shares, say 12,500 multiplied by 15 points, less broker charges, stamp duty, tax and so on...

Online trading platforms for spread betting are often said to be more advanced compared to those to traditional share dealing.

Virtual trading platform are sometimes available - some spread betting companies offer a virtual trading platform for you to practice on. This offers an opportunity for potential spread bettors to understand the market, the dealing process and test trading strategies before committing real money. The ability to practice with virtual money helps reduce the risk of entering into incorrect postions and helps novices to understand the risk involved in dealing with geared products.

Innovation and flexibility (binary betting comes to mind) - Another major advantage that the spread betting companies have over the more traditional firms in the financial markets is that they can offer new products or variations on established products very quickly. Because their products are so called Over-The-Counter (OTC) they don't have to go through the regularity process that major Exchanges do. All financial spread betting companies are however fully regulated by the Financial Services Authority (FSA).

Working from home means that your lifestyle is flexible and you are your own boss - (although we recommend having secondary sources of income).

There are pros and cons to spread betting, Profits are not taxable. However, in spread betting you can lose more than your initial capital. The industry is continually changing shape to appeal to a wider market.

Disadvantages of Financial Spread Betting

Danger of being careless and betting too large a size for your finances - The gearing or leverage means that although you can make money ten times faster and ten times greater but you can also lose money ten times faster and ten times easier and ten times greater if you're not sufficiently trained.

A disadvantage of spread bets is that the bookmaker's spread tends to be slightly wider than commission one might pay to a stockbroker - This partly reflects the gross profits tax which bookmakers pay of 3% of gross profits.

An important disadvantage is that the funding cost (typically at around LIBOR +1-2%) is charged on the entire position (usually this applies even where the client has been required to deposit some funds as margin with the bookmaker) - I suspect that a large part of the bookmakers' income is attributable to the funding charges. For long positions held for more than a few weeks, the cost of funding tends to outweigh saving on stamp duty (although if the investor wants leverage, a spread bet is still probably cheaper than most alternatives).

You can lose more than your initial deposit or capital. - The margin trading involved means that while potential profits are magnified, potential losses are also magnified, except for trades with stop losses. With ordinary share trading, you cannot lose more than the amount you invested in the shares. There is no such limit with spreadbetting.

Another problem with spreadbetting is the sheer volume of capital you have to tie up to keep your trade in play. - It always comes down to how much you are willing to risk on the trade. If you enter a long position on the FTSE at 5950, then betting £10 per point and setting your stop at 5850, it would be very easy on a normal trading day for the FTSE to fall to 5850 - so you close your trade at a loss of £1000 - and still close the day above the 6000 mark. Of course, you could set your stop lower but the lower you set your stop the more of your capital you put on the line and the greater the potential for one wrong trade to wipe out the bulk of your account.

The FSA considers spread betting as a gambling activity - This in itself has its pros and cons...if you tell your wife that you're trading she's more likely to be understandable . However, also keep in mind that winnings are free of tax for a reason - the FSA believes that more people will LOSE than WIN...so you'd better be smart aisle.

Many spread-betting markets are very volatile - Unless you place a 'guaranteed stop-loss' you can suffer very large losses if the predictions go against you.

Spread bet winnings are not taxable, and correspondingly there is no relief for losses.

The investor does not own the instrument he trades - This means that he does not receive any of the benefits he might expect with share ownership, such as dividends. Of course, a stock's dividend is already factored into the trade's bid-offer spread, from which you benefit...

Spread bets have a specified lifetime and cannot be carried over after their expiry date - So the investor cannot hang on hoping for a long run improvement. The only way to continue trading the same instrument is to close the current bet and open a new one. With conventional share dealing, you crystallise your loss only when you sell the shares (no expiry date)

Trading costs in spread betting increase over time - For short term positions held for a few weeks or months, spread betting costs are very competitive compared to ordinary share trading but if you want to hold the position for more than six months, or become a long term investor, it is cheaper to buy the shares in the conventional way. This is because costs are incurred each time a spread bet is 'rolled' over or extended to a new expiry date (all spread bets have a definite expiry date) If you wish to run your bet beyone the expiry date you must roll your position over from one quarter to the next.

The spread is different to the cash market spread - you have to factor a certain increase or decrease in the price before you are in profit (due to the evil bid-offer spread...).

It is difficult to make money in the long term from short selling - The general drift of share prices is upwards; and a short position which goes against the investor can quickly become a very large problem. If you understand the perils of excessive leverage and can avoid the temptations in practice, a spread bet may be the most cost-effective way of taking a short-term position.

The real enemy of spread betters is the kind of range-bound market we saw for much of the earlier part of say 2002. - If you have the FTSE 100 index closing at 5,262 every day for weeks, as it appeared to at the beginning of 2002, it can be a remarkable disincentive to trade. On the other hand spread betters thrive in periods of volatility. When the Dow Jones moves 750 points in a day, first by opening 200 points down and then moving more than 500 up, that's a real opportunity to make money for a sophisticated investor.

Remember : With spread betting there are real charges: They exist in the spread Spread betting agencies tend to promote their service on the basis that one of the advantages of using this method of investing is in the fact that they do not have transaction charges or fees. This is simply not true - the transaction charge is firmly embedded in the spread. If you are serious about spread betting then you have some homework to do, and the very first place you must start is in an analysis of spreads offered by different spread betting agencies. Currently Capital Spreads seem to have some of the tightest spreads around.

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