As far as financial spreadbetting itself goes, it is an excellent way of providing tax free investments without necessarily needing capital. As an example, you can simulate quite closely the returns of a tracker ISA by betting on the FTSE index without needing to fund an account with any more than the amount of money you can afford to lose (i.e the margin). You don't get dividends, but apart from that the performance is quite similar, and of course you can profit equally easily from a falling market as a rising one. You can of course trade into and out of particular indexes or shares very easily and without stamp duty or other charges.
The investment objective of an Index Tracker Fund is to imitate the performance of a specific stock market index or sector index. The fund does this by holding the same equities in the same amount as the index it tracks or in a representative sample of the equities. Some Index Tracker Funds invest in, for example the FTSE 100 Index, which is created from the shares of the top 100 companies in the UK. An advantage of investing in an Index Tracker is that the fund will never perform worse than the stock market, the disadvantage being it will continue to follow the market when it goes down. Some people argue that this is the best way to invest long term in the market because 90% of fund managers always underperform the index.
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Savers with a FTSE tracker fund can also protect their investments with a spread bet. Andrew Edwards, head of trading at ETX Capital, says:
"If you fear an imminent fall in the FTSE and want to protect an index tracker fund wrapped up in a £7,000 Isa, you can hedge the risk with a spread bet.
"Say the index is trading at 4,404. Simply divide the £7,000 value of your Isa by 4,404, which gives you a figure of £1.60 a point. You can then go short on a spread bet by £1.60 a point. If the FTSE then falls by 9 per cent to 4,004, you will make £630, which should be the same as the amount you have lost on the index-tracking fund."
Buying every stock within the index is not possible for most investors but there is a simpler way to create your own tracker fund, just buy the FTSE 100 futures. The futures will also almost perfectly track the index so if the index is up 1.34% over a week the futures will also be up around 1.34%.
One of the alluring aspects about spread betting is that they can be used for betting very small amounts. For example, a tick (minimum price fluctuation, from 6000 to 6001 would be 1 tick) in the FTSE 100 futures contract is worth £10. But a tick using spread bets can be worth as little as 50p. It is therefore possible to trade spread bets with a far smaller capital outlay.
What you have done is to imitate a £11,000 investment in a tracker fund by buying FTSE spread bet.
All profits are now 100% tax-free. But note that the tax-free 'advantage' can come with a sting in the tail, that being that losses cannot be offset against capital gains made elsewhere. This point should be noted with the utmost importance. It is however possible to open a deposit account and set guaranteed stop losses so that your exposure is pretty well controlled. I don't hold with the argument that this is "gambling", except in the sense that conventional investment is, and it's certainly not the case that you will inevitably lose more than you will win, any more than you would inevitably lose more than you gain using a tracker ISA.
As with all investments, you shouldn't risk more than you can afford to lose, and you should get clued up about the underlying investment or index. And you also need to be very clear about how spreadbetting works and what your liabilities are (for example not all stop losses are guaranteed: you can lose more than you have deposited and spreadbetting debts, unlike fixed odds gambling debts, are recoverable in law). Most if not all financial spreadbetting firms are registered with the FSA. The real advantage of mimicking tracker funds in this way is that since spread bets are geared products you only have to put up a fraction of the money to control the asset.
Assume that the day is now Friday 1st October. The December FTSE spread bet is quoted at 5520-5526 and £250 needs to be added to the aggregate fund. Dividing £250 by 5526 you get £0.045 (rounded down) to buy. 4.5p a point seems a very small trade to make but it actually carries exactly the same financial P&L characteristics as investing £250 in the actual market.
You are in control of the risks you take. You always know the margin (also called gearing or leverage). Therefore, you can calculate the exposure you want to commit to in advance. So choice is not between £10,000 in a FTSE tracker or £10,000 on a spread bet that will give you exposure of £1m. Your choice is between £10,000 in a tracker and £100 on a spread bet, with the remaining £9,900 in a high-interest savings account. Apart from the gearing advantage this means that the cost of running the fund is very negligible (the cost of rolling over the trade 4 times a year) as well which means that the majority of your funds will be held in a high-interest bearing bank account.
This option gives you the same exposure to the FTSE as investing all your money in a tracker, and you get the certain return of interest on that £9,900. However, it is not the free lunch it may seem. Remember that your deposit (in this case £100) is used to gear up the total investment. But you pay for that privilege. Spread-betting firms will charge you interest on any position left open overnight. For smaller clients, this will usually be 2 or 3 basis points above UK interest rates.
This is also why it's important to use a spread bet broker that accepts very small bets, unless of course you're thinking of investing large sums. A broker like Capital Spreads would be suitable for this kind of trading because they offer small stakes.
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