Spread Betting is Spreading Fast

Spreadbetting has gone mainstream. What started 30 years ago as a vehicle for city traders to punt, has emerged as one of the most efficient ways of trading any financial instrument in the world. Why now?

Quite simply the success of early providers such as IG Index has in recent years led to a highly competitive marketplace of spreadbet companies offering tighter and tighter dealing prices and ultra-efficient services.

IG Index de-listed in 2004 via a management buyout for £144m. The company returned to the market just 18 months later with a new price tag close to £450m at 120p per share. Some were scornful, with a handful boycotting the new issue in protest at the high valuation. The final judge on value is the marketplace, now trading at 208p with an implied market cap of £700m. Shares currently trade with a 19 times PE ratio. Critics have been silenced. A similar story on a smaller scale was Capital Spreads, listing in February this year with a market valuation close to £30m, shares jumped to value the business at £48m just eight weeks later.

Another indication of the growth in popularity is the number of spread betting companies. Four years ago there were only three main players: Cantor, City Index and IG Index. Since then, the figure has more than trebled.

'For every banker that opens an account, we now have chartered surveyors and taxi drivers doing the same thing. Trading the financial markets is no longer an exclusive club and spread betting has in some way opened the door to allow anyone with an interest in the financial markets to do something about it.'

Interactive Investor, the online investment service, joined the fray recently with the launch of a spread betting service linked to FinSpreads, another operator. Interactive Investor has more than 1.4m account holders, many of whom are sophisticated investors. Just two weeks after launch, more than 500 of these clients have signed up for the spread betting service.

The group also offers a free eight-week course covering all aspects of spread betting. Course notes are e-mailed to participants (who can start the course at any time), with the aim of achieving a good understanding of the subject before they place a trade.

So how does spread betting work? It is similar to ordinary betting, but there are important differences. With fixed-odds betting, such as horseracing, you are either absolutely right (your horse wins and you win a sum whose size is dictated by the quoted odds) or you're absolutely wrong (your horse doesn't win and you lose your stake). With spread betting, the more right you are, the more you can win -- but the more wrong you are, the more you can lose.

Andrew Edwards, the head of trading at ETX Capital, says: 'A particular company will quote a range, known as the spread, of where a particular financial instrument is expected to end up on a given date.' For example, ETX Capital was last week quoting a spread for the FTSE100 futures index of between 4,952 and 4,958 on March 15. 'The customer can bet on whether the price will be higher (buy) or lower (sell) than the company's spread prediction at that date. A standard amount to bet is pounds 1 per point, though this can vary.'

The major risk with spread betting is that if a bet goes wrong you are liable for more than your initial outlay - potentially thousands of pounds, depending on the size of the bet. If you invest in traditional shares, by contrast, the most you can lose is their full value. The risk when spread betting can be reduced by setting predetermined stop-loss limits, however. Stop-loss limits are offered by many spread betting firms - and, indeed, enforced by some, including ETX Capital and Capital Spreads.

The Financial Services Authority is investigating the industry because it is concerned that firms are downplaying the high levels of risk. Last December Cantor Index was fined pounds 70,000 for failing to warn customers adequately about the risks of spread betting in one of its promotions. It is rumoured that another firm is about to be fined for a similar reason. And, irrespective of stop-loss limits, there is a good chance that you will end up losing your outlay as the odds are stacked in favour of the spread betting companies.

'Too many people who have invested in shares recently for the long term have seen a huge decline in their investments, so now people are looking more actively at taking on responsibility for their investments themselves' - says Angus Campbell at Capital Spreads.

Simon Denham, the managing director at Capital Spreads, says: ``It's generally considered that about 80 per cent of bets lose, a level comparable with the experiences of private traders on the various worldwide futures exchanges. However, of the 20 per cent that win, some make very high returns on their money.'

Provided you are fully aware of the risks, spread betting offers several advantages. One major attraction is the ability to magnify returns. A spread betting customer can capture a much bigger return on funds as a percentage of initial outlay. A pounds 10 bet on a UK share offers the equivalent market exposure to holding 1,000 shares in that company, irrespective of the actual price of the shares.

For example, if you placed a pounds 10 spread bet on Marks & Spencer shares, you would make a profit of approximately pounds 10 for every 1p the share price gained (or lose pounds 10 for every 1p it fell). If you were to buy 1,000 M&S shares at the current price of about 360p, you would have to cough up pounds 3,700, plus commission and stamp duty. So the initial outlay on a spread bet would be far less to achieve the same potential outcome.

Capital Spreads requires a minimum deposit of 3 per cent of the underlying value of the shares, so you could gain the same market exposure with a pounds 10 bet on Marks & Spencer for a deposit of only pounds 111 (3 per cent of pounds 3,700).

Denham adds: ``A common problem is that the small deposits required to run positions often tempt clients into taking bigger positions than they would otherwise do when trading in the real shares.'

A further advantage is that -- unlike traditional shares, commodity or index-based investing, where profits rely on upward price movements -- you can benefit from falls with spread betting. You can, for example, bet that a share price will fall, or that the gold or oil price will drop.

And because spread betting is regarded as gambling, you do not pay stamp duty on bets and any gains are tax-free. The flip side is that you cannot offset losses against tax.

The most popular targets for spread betters are the major indices such as the FTSE100, the Dow Jones and the Nasdaq. The top 50 shares in the UK market are also popular among UK enthusiasts. More recently, the gold price and dollar movements have attracted strong interest.

It is easy to start a spread betting account. You sign up online and open an account with a debit or credit card. Provided the spread betting firm can verify your identity, you could be up and running in as little as 10 minutes.