Spread Betting vs Futures – Which is Better?

Spread betting and futures trading are two ways you can make (or lose) money by guessing how the price of something will move, like stocks, gold, or even the FTSE 100 index. They’re different in how they work, so let’s break it down in simple terms with examples.

What Is Spread Betting?

Think of spread betting like placing a bet on a game. You’re not buying anything; you’re just betting if the price will go up or down. For example, if you think the FTSE 100 will go up, you place a bet of, say, £10 per point. If it goes up by 10 points, you win £100. If it goes down by 10 points, you lose £100.

Key Features of Spread Betting:

• Tax Efficiency: In the UK and some other jurisdictions, profits from spread betting are exempt from capital gains tax and stamp duty. However, tax laws may vary, so traders should consult a tax advisor.
• Leverage: Spread betting is leveraged, meaning you can control a large position with a relatively small deposit (margin). While this amplifies potential gains, it also increases the risk of significant losses.
• No Ownership: Traders never own the underlying asset; they merely speculate on its price movement.
• Flexibility: Spread betting offers access to a wide range of markets, often with the ability to trade both long and short positions.
• Guaranteed Stops: Spread betting platforms often offer guaranteed stop losses, which can protect traders against large, unexpected market moves, albeit for an additional cost.
• Accessibility: Minimum bet sizes on spread betting can be as low as 50p per point, making it a more accessible option for beginners or cautious traders.
• Rolling Dailies: Spread betting includes “rolling daily” bets, which are short-term trades that automatically roll over to the next day, helping you stay in a position without committing to a long-term bet or paying for a specific expiry.

What Are Futures Contracts?

Futures are like making a promise to buy or sell something (like oil or gold) at a set price in the future. Unlike spread betting, these contracts are standardized and traded on exchanges. For example, if you promise to buy oil for $70 a barrel in 3 months, you’re locked into that deal, unless you sell the contract beforehand.

Key Features of Futures:

• Standardization: Futures contracts are standardized in terms of contract size, expiry date, and other parameters, making them highly liquid and tradable on major exchanges.
• Leverage: Like spread betting, futures are leveraged instruments, requiring a margin deposit. The leverage can result in substantial profits or losses.
• Regulation: Futures trading is highly regulated, offering transparency and a level of security for participants.
• Ownership and Delivery: While most futures traders close their positions before expiry to avoid delivery, contracts can require the physical delivery of the underlying asset, especially in commodities.
• Transparency: Futures prices are publicly available, providing traders with clear and transparent pricing based on market supply and demand.
• Liquidity: Futures markets often have better liquidity for institutional-grade instruments like commodities and indices.

A futures contract is the obligation to take delivery of a commodity or financial product at a price agreed today or now for delivery at some time in the future. A futures contract is dealt on an exchange, which means that the price is transparent and it is operated through the clearing system.

The main futures contracts are divided into the financial and commodities areas. With commodities, you’ve got most of the agricultural crops – cocoa, coffee, wheat, soya beans. Then you get the base metals, precious metals, energy – gasoline contracts, oil contracts. In the financial markets, you’ve got various government bonds, currency contracts, interest rate contracts and stock indices such as the FTSE and S&P. There are futures contracts on most open-market type instruments. Where there are free-flowing markets, futures contracts generally exist.

‘I spend hours every day talking to customers asking me why they haven’t got an execution on their order. The problem is, you may be wanting to take a profit in, say, gold at 2420 and you see on the screen that the June or April contract traded at 2420. But, unfortunately, only one contract may have traded at 2420 and you weren’t at the front offer. What I can then do is get an official time and sale from the exchange. It’s very useful to be able to settle any dispute. But the main importance of transparency, from the trader’s point of view, is knowing exactly where the market is and that it’s fair.’ – Futures Broker

Comparing Spread Betting and Futures

1. Market Accessibility:
   • Spread betting platforms typically offer access to a broader range of markets, including over-the-counter (OTC) instruments and niche markets, such as political or sports events. Futures trading focuses on standardized contracts available on major exchanges.  Spread betting and CFD providers generally offer better liquidity for equity products compared to single-stock futures on LIFFE (London International Financial Futures and Options Exchange). This is because these markets are retail-oriented, with many participants creating a more fluid trading environment for these products.  Futures markets, especially those dealing with financial instruments like commodities, indices, and exchange-traded financial futures, have much better liquidity.
2. Cost Structure:
   • Spread betting costs include the spread (difference between the buy and sell price) and overnight financing charges for holding positions. Futures trading involves commissions, exchange fees, and potentially platform fees, which can add up, especially for frequent traders.
3. Tax Implications:
   • Spread betting profits are tax-free in some regions, whereas futures trading profits are usually subject to capital gains tax. Additionally, futures trading losses can offset taxable income, unlike spread betting losses.
4. Flexibility:
   • Spread betting offers smaller position sizes and the ability to create custom contracts for short-term timeframes. Futures contracts have fixed sizes, which may not suit all trading budgets.
5. Regulation and Security:
   • Futures trading is conducted on regulated exchanges, offering higher levels of oversight. Spread betting, while regulated, operates through brokers and lacks the transparency of exchange-traded products.
6. Risk and Leverage:
   • Both instruments use leverage, but the margin requirements and potential for losses differ. Futures often have higher margin requirements than spread betting.
   • Futures traders rely on market mechanisms for stops, while spread bettors can use guaranteed stops to limit risk.
7. Pricing Mechanics:
   • Futures prices reflect the spot price adjusted for factors such as interest rates and dividends. Spread betting often mirrors futures prices, but with a wider spread to incorporate costs.
8. Scalping Costs:
   • For short-term traders, futures contracts typically offer tighter spreads and lower costs compared to spread betting. Spread bettors face higher effective spreads, making scalping less viable.

Adjusting Risk and Position Sizing in Spread Betting vs. Futures

In spread betting, risk is straightforward to calculate. For example, if you buy the FTSE at £10 per point and set a stop loss 100 points away, your maximum risk is £1,000 (£10 per point x 100 points). This simplicity makes spread betting appealing to beginners.

In futures trading, risk is managed by understanding the contract size and multiplying it by the point value and stop loss level.  The first thing you have to know is the contract size which you’re trading, and I suggest that if you don’t, then you shouldn’t be trading. In the case of the FTSE, for example, it’s £10 a point. In the case of gold it’s $100. That’s because each contract is 100 ounces of gold. So you simply multiply that by the stop loss level down to which you are prepared to risk.

For example, trading the FTSE futures contract involves a standard size of £10 per point. If you set a stop loss 100 points away, the risk would similarly be £1,000 per contract. Futures traders often use advanced position sizing techniques and margin requirements to control exposure.

Use Cases

• Hedging: Futures are ideal for hedging existing portfolios due to their standardized nature and market transparency. Spread bets can also be used for hedging but lack the same institutional-grade precision.
• Speculation: Both instruments allow traders to speculate on price movements, but spread betting is more cost-effective for smaller or retail traders seeking tax efficiency.

Who Should Use What?

• Spread Betting: Perfect for beginners or private traders who want flexibility, smaller bets, and tax-free profits. Example: If you think Tesla stock will rise tomorrow, you can bet £5 per point and cash out quickly.
• Futures: Best for pros and institutional traders who need transparency and want to hedge large investments. Example: If you’re a coffee producer and worry prices will drop, you can lock in today’s price with a futures contract.

The futures markets were originally set up not for speculation but for protection. You produced your coffee in Brazil and it took three months for it to get here, meanwhile, the price would change. So you went to one of the coffee houses in London and agreed the price today for delivery in three months’ time. Now that still happens an awful lot, so the trade houses will be in the market perhaps forward hedging for a year or two. Likewise, the banks may be in there hedging interest rate movements, and you have people who are protecting their portfolios or trying to gain extra income from their portfolios. They’ll all mostly be long-term strategic traders.

As far as size is concerned, a proper trader can see how many contracts are for offer, at what price and then the prices behind them. So before he actually goes into a trade, he will know he can get the fill at these different prices all the way up. Then he can either back off and not trade, or decide to trade, or he can put a bid or an offer in at his price and let people come into it.

One point I’d like to expand on is that a futures contract is a standard contract and the FTSE, for example, is traded in lots that are £10 a point. A smaller or retail trader can trade in lesser amounts, in pounds per point, so they can design their own contract size. That is one benefit that spread betting has over futures trading.

Key Takeaways from Industry Insights:

• Futures trading offers institutional-grade tools and transparency but comes with higher costs and complexity.
• Spread betting provides flexibility and accessibility, especially for retail traders, but may be less cost-effective for short-term strategies.
• Liquidity and market access differ significantly, with futures dominating institutional markets and spread betting catering to retail interests.
• Tax implications are a major deciding factor, with spread betting favored by those prioritizing tax efficiency.

Conclusion

Both spread betting and futures offer unique advantages and risks, catering to different types of traders. By understanding their key features and differences, you can make an informed decision that aligns with your financial goals and trading style. As always, consider starting with a demo account or seeking professional advice to navigate these complex instruments effectively.   And remember: Always manage your risk and start small!