Spreadbet Charges and Funding Costs


Q. Is it normal to open a longer term position at a price which is actually lower than the current price?


Share
I opened a Bradford & Bingley PLC 16 Sept long position yesterday at 174.56. This is when the share was trading yesterday at around the 185s levels.

Is it normal to open a longer term position at a price which is actually lower than the current price? Also, what price is this 'future price' based on - I mean there's no future for Bradford & Bingley PLC like the FTSE Future/Dow Future? Also, will this future price follow the market position - I mean if the security goes up tomorrow by 10 units will your quote go up by 10 units?

Also, when I have an open long term position can I also open a shorter term position on the same share (even with the same price per point?) as a hedge if I believe the security is likely to go lower in the shorter term but recover later on?


A: The future price is based on the cash market plus the funding costs, you are correct there is no futures market and therefore the spread betting company is unable to accept market orders for the future contracts because they do not exist, all orders for these contracts are basis of the provider's quote. Also, the future price of a share will often be slightly different to the price trading in the stock market when taking into account the fair value (interest and dividends).

Thereby, the future price is traded at a price which reflects the interest advantage and the disadvantage of foregone dividends. A future price can be adjusted at any time if a share is expected to go into ex dividends (pay out of dividends).

It is not normal to open a future price that is lower than the cash market due to the funding charges - they include the implied interest cost of holding the position from today to the expiry date. Typically dividend yields are less than interest rate adjustments and forward price therefore trades at premium to the cash price. However some stocks with high dividends can mean that the forward price trades at a discount.

So to address your question - such a situation is possible, if a dividend payment is due in this period - in the case of Bradford & Bingley there is a dividend due for payment on 19th March so this would be included in a Sept contract but not in March. The futures price will decay as it gets closer to expiry and will exactly reflect the stock price on the final day. There is a direct correlation between the movement of the stock price and the movement of the futures. Other that this, the price is usually higher as these is a 'cost to carry' factored in. If you keep a long position for a while, you will be paying a financing charge each night, obviously, over time, this adds up. You do not pay financing on a quarterly position, as this is already factored in.

Therefore when considering a hedge on a specific daily price against a future, consider the calculation of a future price :

price = cash price + cost of carry - dividends.

Therefore a rise in a daily price will have an effect on the future however there are other factors to incorporate when doing so.

You can indeed open a short position as a hedge against your long term position, so if you were in the Sept contract you could do a rolling or March against it. You cannot open a short in the Sept contract though as most providers do not allow it and would simply close your open trade (except for IG Index which actually allows you to open a Sept long and short position on the same instrument - to do this you need to make sure the 'Force Open' button is selected on the deal ticket)

Q. Certainly spreadbet charges are (generally) higher and you pay interest over time, but there are other counteracting benefits. What's the interest component referred to here?

A: I'm not sure of your level of knowledge here so if I go down into detail that you already know you'll have to bear with me.

With spreadbets you only actually lay out cash for the margin component of your bet, so you are in effect borrowing the rest of the money to buy the shares from your spreadbetting company. They charge you interest on this.

There are basically two types of spread bets - quarterly and daily.

In the case of Quarterly Bets the interest is included in the price - spelling this out more clearly with a real example -:

THUS (I've chosen THUS because they don't yield a dividend which confuses the calculations)

Bet Mid price
Daily (expiring 2-Mar*) 182.50
Qrtly (20-Mar) 183.00
Qrtly (20-Jun) 185.79
Qrtly (20-Sep) 188.57

So you see you pay a 'premium' for the futures bets and the premium increases the further into the future you go. (This amounts to a compounded interest charge of c. 6% pa currently).

If you bought (or sold) the September position and the price of the underlying stock did not move at all up to 20-Sep the price of the bet would gradually erode to close on 20-Sep @ 182.5 so you would have paid 6.07 for holding the position (or if you were short would have been paid 6.07 by the SB company).

Simply that's the interest on a quarterly SB. You need to be aware also though that when you buy and sell spread bets you also pay the Normal Market Spread PLUS the spread betting companies spread (and the SB spread becomes slightly wider for the longer term positions).

For daily spread bet positions you pay no interest on the day, but if you want to hold the position open into a second day, the bet will 'roll-over' closing at the first days closing mid price and re-opening at the second days opening mid price - you will be charged interest separately for the roll over.

Please note that this reflects the way both IG Index and treat interest - other spread betting companies might vary from this slightly but the basic principle ought to be the same.

* IG Index don't actually quote the value of their daily positions when the market is closed but I've based the 182.5 on the market mid price at close which should have matched the closing mid price of the IG daily spread bet.

 ...Continues here - Technical Market Indicators and their Workings


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