What is spread betting and how does it work?
Spread betting is a derivative product, which means you don’t take ownership of the underlying asset but speculate on whichever direction you think its price will move – up or down. If your prediction is correct, you could profit, however if the price moves against you, you would incur a loss.
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What is spread betting?
Spread betting is a tax-free financial derivative that enables you to speculate on a huge range of financial markets, such as forex, indices, commodities, shares and bonds.* And, as you don’t take ownership of the underlying asset, you can take advantage of markets that are falling as well as rising.
Being able to trade in both directions gives you a much wider range of opportunities than traditional buy-and-hold investing.
Main features of spread betting
The sections that follow explain some of the main features and uses of spread bets:
What do ‘long’ and ‘short’ mean in spread betting?
Spread betting enables you to speculate on markets that are decreasing in value, as well as those that are increasing. So, while you could opt to mimic a traditional trade that profits if the underlying asset rises in price – known as ‘going long’ – you could also open a spread bet that will profit if the underlying asset falls in price, known as ‘going short’.
Let’s say you thought the price of gold was going to decline, so you decide to go short by opening a spread bet to ‘sell’ the underlying market. The loss or gain to your position would depend on the extent to which your prediction was correct. If the market did decline, your short spread bet would profit. But if the price of gold increased instead, your position would make a loss.
What is leverage in spread betting?
Leverage is a key component of spread betting, as it enables traders to gain full market exposure for a fraction of the underlying market cost.
Say you wanted to open a position on Facebook shares. As an investor that would mean paying the full cost of the shares upfront. But if you decided to spread bet on Facebook shares instead, you might only have to put down a deposit worth 20% of the cost.
Trading using leverage magnifies profits and losses, as these are calculated based on the full value of the position, not just the initial deposit. This makes it important to create a suitable risk management strategy and to consider the full amount of capital that you are putting at risk.
What is margin in spread betting?
When you open a spread betting position, you would put down a small initial deposit – the margin – which is a percentage of the full value of the trade. This is why leveraged trading is sometimes referred to as ‘trading on margin’.
There are two types of margin to consider when spread betting: the deposit margin and the maintenance margin. The deposit margin is the initial funding required to open the position, which is often presented as a percentage of your total trade. Maintenance margin refers to the additional funds that might be required if your open position starts to incur losses that are not covered by the initial deposit. If this happens, you could get a notification from your provider – known as a margin call – asking you to top up the funds in your spread betting account. Failure to do so can result in your position being closed and the loss to your account being realised.
How does spread betting work?
Financial spread betting works using three different components. The spread, which is the charge you pay to open your position, the bet size, which determines the amount of capital you put up, and the bet duration, which dictates how long your position will remain open before it expires. Here’s an introduction to all three:
What is the spread?
The spread is the difference between the buy and sell prices, which are wrapped around the underlying market price. The costs of any given trade are factored into these two prices (known as the offer and the bid), so you will always buy slightly higher than the market price and sell slightly below it.
If the FTSE 100 is trading at 6545.5 and has a one-point spread, for example, it would have an offer price of 6546 and a bid price of 6545.
What is the bet size?
The bet size is the amount you bet per unit of movement of the underlying market. You can choose your bet size, as long as it meets the minimum we accept for that market. Your profit or loss is calculated as the difference between the opening price and the closing price of the market, multiplied by the value of your bet.
We measure the price movements of the underlying market in points. Depending on the liquidity and volatility of your chosen market, a point of movement can represent a pound, a penny, or even a one hundredth of a penny. You can find out what a point means for your chosen market on the deal ticket.
If you open a £2 per point bet on the FTSE 100 and it moves 60 points in your favour, your profit would be £2 x 60 points = £120. If it moved 60 points against you, you would lose £120.
What is the bet duration?
The bet duration is the length of time before your position expires. All spread bets have a fixed timescale, but these can range from a day to several months away. You are, however, free to close them at any point before their designated expiry time, assuming the spread bet is open for trading.
Here are two examples of spread bet durations:
- Daily funded bets. These spread bets run for as long as you choose to keep them open. They offer our tightest available spreads, with a default expiry some way off in the future. We will make an adjustment to your balance to reflect the funding costs of your position for each day that the bet remains open. You would generally use a daily bet to speculate on short-term market movements
- Quarterly bets. These are futures bets that expire at the end of a quarterly period. These bets have funding costs built into the spread. You can roll quarterly bets into the next quarter if you let us know in advance
Example: Apple spread bet
Say Apple is trading with a sell price of 19505 ($195.05) and a buy price of 19520, but you anticipate that Apple shares are going to rise in the next few days. You decide to go long on (buy) Apple shares for £10 per point of movement at 19520.
If Apple shares did rise in price, you might decide to close your trade when the sell price hits 19550. As the market has increased by 30 points (19550 – 19520), you’d be coming out with a profit of £300 (30 x £10), excluding any additional costs.
If the market had fallen in value instead, down to a sell price of 19450, you would have ended up with a loss. As the market had moved by 70 points (19520 – 19450), you would have made a loss of £700 (70 x £10). Once again, not including any additional charges.
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* Tax laws are subject to change and depend on individual circumstances. Tax law may differ in a jurisdiction other than the UK.