Comparing the Costs of Spread Betting, Share Dealing (and CFDs)
Nov 7, 2011 at 5:19 pm in General Trading by
Quite a few years ago, my first forays into financial trading were via a regular share dealing account. While I thought I had the right strategy of cutting my losses (quickly via stop orders) and letting my profits run, I found it difficult to make this strategy profitable in practice. The reason was that each time I stopped out, I suffered not only the bid-ask spread plus the stop distance, but also the stamp duty and the round-trip dealing fees of (at the time) up to 2 x £12.95. On very small ‘investments’ of (let’s say) £500 these dealing fees alone could account for more than 5% lost on each failed trade.
Thank Goodness for Spread Betting
Thank goodness for spread betting, which allows me to stake small amounts of money without incurring stamp duty plus disproportionately large dealing fees on quick-failing trades. All you lose on a failed trade is the bid-ask spread and the stop distance (of course). While it’s true that my rolling spread bets attract daily financing charges whereas regular shareholdings don’t, it is also true that I only pay those charges on successful positions while “letting my profits run”. And I’m getting the benefit of leveraged gains in return.
A Cost Comparison Spreadsheet
Some months ago I set about constructing a spreadsheet to calculate the difference between spread betting costs and regular share-dealing costs for different position sizes held over various lengths of time. It looked like this:
You don’t need to worry about the specific numbers so much as the general principle that spread betting costs less (the cells coloured green) for shorter holding periods and smaller position sizes. In this example, spread betting is more cost effective than regular share dealing when a £100-equivalent position size is held even for as long as five years, and a much larger £10,000 position size can be held more cheaply than a regular shareholding for up to a month.
In this spreadsheet I have assumed that the London Inter-Bank Offered Rate (LIBOR) stands at 1%, that the spread betting company will charge 2% above LIBOR, that the spread betting company’s bid-ask spread will be a little wider than a regular stockbroker’s spread, and that the regular stockbroker would charge a flat fee of £10 on share purchases and sales.
If interest rates ever again reached the dizzying heights that they reached in the 1990s (i.e. 15%) the effect would be as shown in the following revised spreadsheet — fewer green cells (where spread betting is more cost-effective) and more pink cells (where regular share dealing is more cost-effective).
It still looks good for short- to medium-term spread betting, but In the interests of fairness I should point out that a die-hard ‘buy and holder’ — who never sells and who has a very large amount of capital to ‘invest’ — would be better off with a regular share holding than with a rolling spread bet.
The Calculations
Anyone who is interested in reproducing my cost comparison model, or who wants to take it further, will be interested to know that my calculations are as follows:
In the holding-period-independent Share Dealing Costs row (shown yellow):
ShareDealingCost = Dealing Fee + (StampDuty * Position Size) + Dealing Fee
In the spread betting difference cells (shown green and pink):
CostDifference = Extra Spread * Position Size + (Position Size * Days * Finance Rate / 365) – ShareDealingCost
Thanks to conditional formatting in the spreadsheet, each of these cells changes from pink to green if the spread betting cost is lower than the share dealing cost for the particular position size and holding period.
What about the leverage?
My simple analysis assumes that a £1-per-point spread bet on a 100p stock is the same as a £100 traditional ‘investment’ in the same stock; because in both cases you lose £100 if the company goes bust and you make £100 if the share prices doubles.
Hang on a minute! To stake the equivalent of £100 in a spread betting account, you do not actually have to deposit the full £100. Thanks to the leveraged nature of spread betting — for which you pay those financing charges — your £100-equivalent spread bet ‘investment’ would require you to deposit a much lower amount… like £20*. So perhaps we’d be justified in nudging all of those green cells to the right, to reflect the fact that a £100 spread betting deposit is potentially equivalent to a £500 ‘investment’, thereby making spread betting even more cost-effective.
* note that you would still be risking the higher amount, and the spread betting company would come knocking if your bet turned sour!
…and CFDs?
I’ve dabbled with Contracts-for-Difference, but to be honest, I tend to avoid them. I don’t particularly like their cost profiles, which are more like traditional share holdings insofar as charging you up-front dealing fees that sting you on those quick stop-outs.
Conclusion
For day traders, swing traders, and other short-to-medium-term traders, spread bets should always be more cost-effective than traditional share holdings.
For small players, which I would encourage most spread bettors to be, spread betting will almost always be more cost-effective. But let’s be clear about what we mean by “small players”. As my spreadsheet shows, in a low interest rate environment a “small player” can potentially leverage a modest £2000 deposit up to a much bigger £10,000 and hold this position for up to a month more cheaply in a spread betting account than in a regular share dealing account.
The not-so-small player can diversify a larger amount of money into several such positions because, in a spread betting account, each separate position does not attract a new set of dealing fees. Whereas the cost structure of a regular share dealing account encourages the ‘investor’ to hold a single large position most cost-effectively, the cost structure of a spread betting account rewards the trader who diversifies into a number of smaller separate positions. And we all know that diversification is no bad thing.
Tony Loton is a private trader, and author of the book “Position Trading” (Second Edition) published by LOTONtech.