What is Financial Spread Trading?

Spread Trading offers the private investor a fully tax-free alternative to trading the worlds financial markets. It may be difficult to tax as a lot of people tend to lose, I would guess because they don’t do the research or properly learn the implications. However, financial spread trading isn’t new. It’s been around for more than 30 years, but it’s only been in the last few years that it’s really grabbed the attention of private investors. In this guide we discuss the place of spread bets within an investment portfolio, as opposed to a trading account.

• Why trade Spread Bets?
• How do I trade Spread Bets?
• Nuts and Bolts of trading Spread Bets
• Managing your Trade
• Trading Strategy

A spread trade allows an investor to speculate on whether the price quoted for a given financial instrument is likely to go up in value (strenghten) or go down in value (weaken). The instrument could be an equity such as shares, or a bond, commodities or foreign currency pairing (example dollar-euro). Or, it could be an index which represents the top shares in the United Kingdom, USA or other country. Financial spread betting different from physical share dealing because you don’t actually own the underlying instrument. Investors have to place a deposit into their spread betting account and then they will use this ‘leverage’ (sometimes called margin) to speculate solely on price movements.

NOW THERE’S A WAY TO MAKE THE MOST OF MARKETS THAT FALL AS WELL AS RISE

The ‘speculating’ on price movements is key as it allows them to profit both when a market is rising and also when it is falling. Spread Betting, however carries a high degree of risk to the investor. Due to fluctuations in valuation, the investor may not get back the amount of the original investment, and in certain circumstances be liable to pay a far greater sum.

There’s also no commission charges, the transaction costs can be lower and you don’t pay tax on any profits you make.

* Profits made by a UK residents from spread trading are exempt from UK Capital Gains Tax, stamp duty and income tax, however tax treatment depends on your individual circumstances and may change in the future.

Margin Trading

Spreadbetting allows traders and investors to trade on margin. In spread trading, margin permits you to trade depositing only a percentage of your trade’s total market value in your spread betting account. This enables investors to make a bigger profit or loss (of course they are hoping for a profit!) than the amount they put down on a trade.

An example of margin in spread betting

If a trader acquires £5,000 of securities via a house broker, he normally has to pay the full £5,000 market value to do so. On the other hand, if you open a spread betting trading position worth £5,000 with a spread trading company, you may only have to pay between 5% and 20% – or £250 to £1000 to open the position. This deposit, which is required for each open position in your account, is referred to as the margin requirement.

When you open a position on your spread betting account must hold sufficient funds to cover the margin requirement. You must also take care to maintain the margin requirement deposit level in line with any unrealised profits/losses going through your spread betting account. If your margin deposit level falls below the margin threshold you will be required to deposit more funds or close or reduce one or more of your positions. Note that margin is there to protect you and the spread betting company – ensuring that traders don’t overstretch themselves.

Of course leverage can be dangerous and introduces more risk but more risk is just what many spreadbetters seek. And because these products have been developed with stop losses and guarantees, and much tighter spreads than they used to have, used sensibly and with a full understanding they may be the ideal sort of vehicle for frequent traders.

How it Works

In the stock market, when you want to deal in physical shares, you go to a stockbroker and they will quote you two prices. The lower of the two prices, which is the one you will pay if you are selling shares, is called the bid price. The higher quoted price is what you will have to pay if you are buying shares, is called the offer price. The difference between the two prices is called the ‘spread’.

In spread betting the principle is exactly the same, two quoted prices, bid and offer. If you believe the share price will go up, you buy at the offer price, also known as a long position or going long. If you believe the price will go down you sell at the bid price, also known as a short position or going short.

For instance, let’s take the FTSE 100. Say the FTSE 100 index is currently at 5782. You go long (buy) at £10 per point. In the next few weeks the FTSE moves 30 points to 5812 in the direction of your trade, when you decide to exit the position. You close the trade and make a gain of £300. This is because the FTSE 100 index has gone up 30 points in your favour, and your stake amounted to £10 per point, i.e. (5812-5782) x £10 = £300.

How much it Costs

You don’t pay any brokerage fees or commission and there’s no stamp duty to pay. And, with its unique tax status, you don’t pay any tax on any profits you may make. Remember, profits made by a UK resident from spread betting are exempt from UK Capital Gains Tax, stamp duty and income tax, however tax treatment depends on your individual circumstances and may change in the future.

When you spread bet, you don’t pay the full value of the instrument but, before you trade, you do need to deposit money in your trading account. This is what you’ll use to fund your trades.

You can then place bets with a deposit known as ‘initial margin’. The exact size of the margin depends on the type of instrument you’ve chosen to bet on, but it usually ranges from 1% to 10%.

Let’s look at a Vodafone trade example.

Let’s assume we’ve place a £10 per point bet at 130.60 pence. Say the margin requirement for Vodafone was 3% so our initial margin would be £39.18.

This is worked out by:

£10 x 130.60 offer (buy) price = £1,306

3% margin of £1,306 = £39.18, which means that our margin requirement to place this trade is £39.18

In any case my suggestion is read all you can on spread trading and start small..it can be a tricky business spreadbetting.

What about Financial Spread Betting and Tax?

As mentioned earlier, financial spread betting is currently free of UK capital gains tax and stamp duty. Of course the legal environment could always change, but ‘till then, this will be one of the most attractive aspects of financial spread betting. After all, why bother going through a stock broker, paying commissions, stamp duty and capital gains tax (if you exceed your yearly tax allowence) when you can ‘trade the value’ of shares and other financial instruments tax free. Sounds too good to be true eh? Well there is a worthy note of caution here. Because financial spread betting is tax free, you aren’t afforded any of the tax protection or relief you can have access to when trading other financial instruments…every rose has it’s thorn after all.