The Origins, Present and the Future of Spread Betting

History

Spread betting, invented by an American, Charles K. McNeil in the late 1930's, and only introduced in the United Kingdom in the 1980's, is the term used to describe bets placed on the result of an event where the 'payoff' is based on the precision of the bet, rather than on a simple win or loss. A bet is made against a 'spread' or index, and is decided on whether the result is above or below the spread.

It all started in 1974 when IG Index allowed city traders to bet on the future direction of the price of gold. This early phase of growth was not spectacular. But it was steady and by the mid- to late-1990s, there were half a dozen established players.

Why is it called Spread Betting?

The truth is that spread betting firms do not like being called betting companies. Unlike a traditional bookmaker where it is the bookmaker's view against the client, spread betting companies claim to hedge all bets. This means that when the client places a trade on a financial instrument, for example a share, then the spread betting company immediately places the corresponding equivalent in the open market. The FSA, the watchdog of the financial service industry, has declared that in order for profits of investors to be tax-free it must be called a betting company. Unlike with a traditional stockbroker where the investor pays capital gains taxes on profits, all profits made through a financial spread betting company are tax-free per law. However, the client will pay a spread, which is slightly bigger than in the real market. This will cover commission, stamp duty and tax for the spread betting company.

A tax-efficient way to gain exposure to the financial markets

Unlike with a lot of investment products, the charging structure for spread betting is relatively straightforward and simple to understand:

• Charges - There are largely no dealing commissions, management fees or quarterly administration fees.
• Capital Gains Tax - Essentially, there is no capital gains tax to pay on any profits that you might make from your spread betting gains over the year.
• Betting Tax - Even more good news; the old betting tax regime was subverted in 2001 and there is no longer any tax or duty at the point of placing you bet. (Under the old regime punters had to pay a 9% tax on their stake - under the new tax regulations, the spread betting companies are charged 15% on their gross profits).
• Other Duties - Finally, whereas share trading incurs 0.5% Stamp Duty on all purchases and a £1 PTM (Panel of Takeovers and Mergers) fee on all transactions over £10,000 - spread betting is again free.

Will Financial Spread Betting always be Tax-Free?

The Spread Betting industry employs a lot of people and if you removed the tax-free status then you would destroy the industry overnight. Consider how much money the Treasury receives directly from the industry already in corporation tax and all the personal income tax that the personnel is paid. That's a lot of tax of income.

And anyway what happens to the tax-free winnings of the spread betting punters? Sure they don't pay direct tax on it, but I'd bet that at least 80%-90% of the money filters back into the economy.

So what's the catch and how do the spread betting companies make their money?

All the costs associated with spread betting are included in the bid-offer spread; this includes all the firm's admin costs and the costs associated with hedging the risk on any open positions. What this means is that the wider the spread on any trade, the more you are paying for that trade. Thereby it is worth comparing the different firms and finding the best one for the markets in which you are interested.

What to consider when choosing a Spread Betting Company?

Mainly spread tightness, spread skewing, slippage, time to fill, price expirations, hitting stops, dispute resolution, phone trading (time to answer, manner) internet trading (platform, functionality, ease of use, reliability), charting, 24 hr trading, markets covered and statements.

How safe are Client Funds?

The risk of your spread betting company going bankrupt is highly remote and even then as a UK segregated client you have lots of protection (even if you're not in the UK and dealing with a British broker). This has never really troubled me - there was one 'bob outfit' [recall the Global Trader GT247 saga] that went into liquidation last year but you do not have to worry here. Read more about Segregation and Ringfencing of Client Funds (opens in a new window).

Becoming a Millionaire from Spread Betting?

Great fortunes have been made and lost financial spread betting, Mike Ashley - owner of Newcastle United is reported to have lost £300 million on a long bet on HBOS while both Vince Stanzione (who reportedly made over 2 million spread betting commodities in 2008) and Simon Cawkwell are two examples of self-made millionaires from spread betting. So next time you have a spread betting loss that hurts your wallet and your ego, be thankful you didn’t loose £300mil! Also, it's worth remembering that when you get into spread betting, you have to be rational, cool-headed, and leave your ego/greed out of it. See the section So you want to be a millionaire? for more info.

Is there Something Suspect or Morally Dubious about Spread Betting?

The brief answer is no, but real events some time ago involving the Spaniard and the Plumber have raised the question.

Continues here - Regulatory action to bite; CFDs and spread betting attract increased attention from the FCA