Advantages and Disadvantages of Financial Spread Betting

Advantages of Financial Spread Betting

Advantages of Spread Betting
Easier to understand than other financial instruments - The process is less complex than that for options, futures and contracts for difference.

Tax free winnings - Tax is just another overhead and tax avoidance scheme/s are a welcome and widely accepted practice to increase profits. So eliminating it I have an immediate advantage over somebody who cannot avoid it. This is a key advantage of spread betting in that gains are free of tax (no capital gains or income taxes and no stamp duty). When using a traditional stockbroker, all profits are subject to Capital Gains tax. Moreover, spread bets are free from stamp duty, currently charged at 0.5% on all share purchases. This is because a spread bet is a contract between the client and the spread betting company and no physical exchange of shares actually takes place. The only real tax due on spread betting is a 3% betting tax charged on the firm's gross profits - which is absorbed by the company in the spread.

By itself the stamp duty exemption means that taking spread betting positions on stocks is cheaper than directly buying the underlying stocks for trades held for up to a few weeks, although if held for longer periods the financing charges associated with spread betting will add up. The savings do add up. For a purchase of £5000 of any share, the stamp duty charge paid to the Government is £25. A trader who deals twice a week, 52 weeks a year will end up paying £2,600 in stamp duties alone. If you were to trade £25,000 in normal share transactions each trading day via a stockbroker, you would pay the Government (brother Sam!) more than £31,500 in stamp duty over a year.

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There are pros and cons to spread betting, Profits are not taxable. However, in spread betting you can lose more than your initial capital. The industry is continually changing shape to appeal to a wider market.

Investors Chronicle quotes the case of full-time trader Roy Mitchell: 'On an average trade, Mr Mitchell trades £10,000-worth of Man Group shares in spread betting, for which he pays £68 in commission and £2.25 for every lot that is filled. The latter amount might not sound much, but so far this year he has paid about £3,200 getting his orders filled.' 'In one of the many trades of his favourite share Man Group, he sold the shares at 550p and bought them back at 545.5p, locking in a gross profit of 4.5p, equivalent to £382 after brokerage fees were paid. This profit would only be £110 if he had to pay stamp duty of 0.5 per cent. Mr Mitchell trades spread bets because there is no capital gains tax on the profits, which is not the case for direct share trading and for contracts for difference (CFDs).'

Also, as far as I'm concerned one of the biggest advantages of spread betting is not just that no CGT or income tax is payable - but that I don't have to organize the tax-related records that comes with frequently buying/selling/reducing/increasing real shareholdings.

Potentially massive returns on low investments due to high leverage - Since spread betting is a product traded on margin you don't have to pay the full cost of the trade upfront - known as trading on 'margin'. The majority of traders already know that some form of leverage must be used if you want to make short term trades and reap any benefit from small movements in price. Low margin requirements normally allow good leverage for larger positions. In most cases only between 7.5% and 10% is required as margin to be deposited with the spread betting firm. A margin of 10% would mean that a 2% in the share price would generate a 20% return. This is called margin trading and is useful for magnifying potential profits on equity, commodity or index positions. So with margin trading an investor could potentially buy the equivalent of £100,000 of UK stocks while only putting down between £5000 and £10,000. This also means that you do not have to tie up all your capital when you spread bet, which frees up capital for other opportunities as they come along while earning interest in the bank.

Make phased exits without additional broker fees - One big advantage of using spreadbets rather than actual share purchases, is that one can make phased exits without incurring duplicated or triplicated broker fees. This can have tremendous psychological value. I could for example determine beforehand that I will sell say one third on a 10% price fall, another third at 15% down, and only sell the remainder if the price is 20% down. (Or using 5%,10%,15% or whatever). I can thereby feel that I have been fair to that stock and given it every chance to rebound. Whereas with an actual shareholding the avoidance of multiple brokerage fees means setting a fixed level at which I sell the lot or don't - and that "all or nothing" moment is where many investors get stressed and come unstuck by feeling they really ought to give it "one more day" or whatever, only to then find themselves tipped into a sharp fall that is triggered by other market participants who did sell. There are occasions where I will phase my way into or out of a particular bet in £1pp increments. (£1 per point is the equivalent of buying or selling 100 shares, which is too small an increment to be viable if repeatedly applied to a real shareholding).

It is commission-free - All the costs associated with spread betting are built into the bid-offer spread. In contrast if you go through the traditional broker route you will need to pay your broker twenty pounds a go at least to buy and sell the shares for you. This is more of an advantage when dealing frequently in small sizes. Thus, although traditional share dealing is excellent for someone with a large account who wants to buy and hold, spread betting is much more cost effective for someone who is looking into buying or selling, three, four, five times a day, if you like - even twenty trades a week.

Dividend payments - Some long-term stock investors often point out that spread betting providers don't pay out dividends on shares as an argument against spread betting. This is simply not true. For daily rolling bets dividends are credited to your spread betting account by your provider the day that they come into effect. For futures bets the value of the dividends is deducted from the spread. So if you are trading a share that entitles the holder a 15p dividend at some future date, the spread betting company will quote a price which is 15p less than it would have been, in the circumstance that a dividend had not been payable.

Possible tax savings - For example, if you own a share paying a dividend, income from that dividend is taxable at your current income tax rate. Spread bets do not pay dividends. Instead, the dividend payment is build into the bid-offer spread so the holder of a position in a dividend-paying share will reap the rewards in the form of a tax-free capital gain rather than taxable income.

The ability to trade in amounts less than the standard market contract sizes - there are companies that allow you to trade for as little as 10p per point, giving you the opportunity to develop confidence and experience.

The ability to trade outside market hours - Most spread betting companies are open 24 hrs a day from Sunday night until Friday night. i.e. in many cases it is possible to deal when the traditional markets are closed. Contrast this with normal market trading hours which run from 8.00 am to 4.30 pm!

Controlled risk bets - A controlled risk bet is one which has a special kind of stop-loss order attached to it. When you open a controlled risk bet you pay a small premium though an increase in the bookmaker's dealing spread, and you choose a stop loss level at which if the bookmaker's quotation reaches it, your bet is to be automatically closed out.

No huge capital outlay required - You can start to trade with as little as £100 on deposit and use as little as 1p to "bet" on the price movement of shares, market indices (such as the FTSE, NASDAQ, Wall Street (Dow Jones), S&P, Nikkei), currencies or commodities (such as gold or oil) Also, there is no different spread quoted for a smaller size bet. Therefore small positions are not penalised like they can be in cash markets.

Credit facilities - Subject to your experience and financial status most spread betting firms will offer you a credit account which eliminates the need to tie up capital.

Immediate dealing - Executions are completed within 1 minute. This is because spread betting companies are not brokers, so all trades are contracts between the client and the spread betting company. Thereby each execution is not necessarily traded over an exchange and there is no delay in routing the order. Also, in the real markets you can only trade if there is another party on the other side willing to buy or sell at your price AND you get to them first (i.e. before someone else gets the deal). In contrast with spread betting, since you're dealing with a market maker you will in most cases get the trade irrespective what the underlying price, liquidity or spread maybe. This is obvious when trading stocks via direct market access but also applies to other markets. For instance, Capital Spreads quote the FTSE at 1 pt continously from 08.00 till 21.00. However, in practice the FTSE futures market spends a lot of time hovering with spreads of between 1.5 and 3 so you would not get the trade that you might have just dealt with Capital Spreads in the real world.

No currency risk - Dealing in foreign shares can be cumbersome and impractical if you are an average investor. You have to deal with a third party and pay transaction charges. Not only that, but you don't have the currency risk involved: with physical shares (and CFDs), you always need to think about how changes in foreign currencies are affecting your shares. For example, recently, traders found it strenous to balance their books in sterling terms because of the ups and downs of the yen and the US dollar. Spread betting allows traders to bet in pounds per point on international shares. This is unlike CFDs where you are trading in the base currency of the market you are trading. For instance with CFDs if you make a Wall Street trade this will be in US dollars so if the Dow rises by 5% but GBP/USD rises by 5% in the same time frame, you would not have made as much as you originally thought. With financial spread betting, that currency risk exposure is hedged out: you can trade Tokyo Stock Exchange prices as if they were London ones without worrying about the sterling/yen exchange rate!

Get currency conversion rates at favourable rates - One of the most favourable things spread betting and cfd providers can tout is getting currency conversion at very competitive rates. This is because the overhead is much smaller, and you're practically getting realtime market rates - not rates where the bank has padded their profit into it. One provider offered me 50bps without even knowing who I were. That's .5% above interbank. In fact it has been reported that some small corporate firms use spread betting to hedge their foreign exchange exposure. Quoting Simon Denham 'Some companies find it is actually cheaper to hedge their foreign exchange with us than it is to go through their banks. These firms are below FTSE 250, but they want to do several million pounds a shot'. When a smaller company does a foreign exchange hedge deal, they normally won't get a very good rate from a bank in the first place, and the bank will also expect them to put up 20% of the margin. We only ask them to put up 2-3% initially. Of course, they don't get the tax advantage that private investors do - from their point of view, it is simply a known risk in a foreign contract, so they declare it to the Inland Revenue as a hedge position.' says Capital Spreads' Denham.

Wide range of markets you can bet on - Herein lies one of the main benefits of spreadbetting. They deal on most exchange traded contracts that are liquid as well as some not so liquid ones/less accessible ones like Polish Index, (ATX) Austrian Index, (Bel20) Belgian Index, (OMX30) Swedish Index, taiex, zinc, lead , tin, aluminium, carbon emissions, london housing, currencies, options, interest rates, commodities, football (!), horse racing (!), rugby (!) to how many sips of water the Chancellor is going to drink during his Budget speech!! Being able to bet on indices is a great advantage because in my opinion it is far easier to see if the tide is going up or down rathering than looking at lots of different boats to put your money into. Most make markets for bets on stocks, stock options and future options as well from major exchanges. Bets are available on many liquid assets including a wide range of quoted shares, and at some spread betting companies this extends down to companies with a market capitalisation as small as £10m. With some providers dealing in more than 20,000 instruments spread betting may well provide you the opportunity to trade a market to which you may not have previously had access. In contrast, some traditional stockbrokers make you use different platforms or might charge you an extra fee for dealing in international shares.

Spread betting providers also provide you with access to certain far flung markets that it would be quite difficult (if not impossible) for you to do on your own. Try getting a brokerage account in Canada or Hong Kong as a non-resident for instance, access to these markets have traditionally been limited to institutions. The reason such markets are often accessible through financial spread betting is that you don't actually buy the underlying asset. You are speculating on what it is going to do next.

Ability to bet on industrial sectors - Sectors give you a wider view of a market by trading a basket of equities from particular industries instead of individual company stocks, allowing you to avoid individual company risk. Many investors are more interested in the state of industries like the banking or mining sectors rather than individual companies within the sector and providers have introduced sector betting encompassing all the industrial sectors in the UK stock market which makes it simpler to trade macro-trends. There are 28 sectors to choose from. And again you can trade sectors both on the 'long' and and 'short' side.

Ability to go short or long (i.e. you can make money when markets rise or fall) - Shorting allows you to make money not only in rising markets but also in falling markets which means you can trade regardless of whether we are in a bull or bear market. This is key to spread betting, since you do not physically own the share or underlying instrument, but trade solely on the price movement, you can 'bet' on prices moving down as well as up. With stock markets so bearish over the last two years, it has been extremely difficult to make profits as a trader without the ability to go short.

Hedging - A unique aspect of spread betting is the ability to short any instrument, whether it is a stock, a stock index, a commodity or any other financial products offered. This means that in addition to speculating, spread betting also allows for an efficient way of hedging a portfolio of shares. This is akin to buying 'insurance' for stock positions where you take out short positions in the stocks you own. Let's take an example. Suppose we have an investor with a portfolio of blue-chip FTSE 100 stocks who thinks the markets are going to fall over the next 6 months. As opposed to selling his shares and repurchasing them in six months time he can take a short-term 'down' spread bet on the FTSE 100 that fulfills the same function. This will save on transaction fees and if he bought the shares at a much lower price than the prevailing market price then he will also avoid a substantial CGT liability.

Diversification - The only thing free in investment is diversification. Not exactly true but quite close. By allowing you to bet on an index rather than just a share, you can gain instant balanced explosure to the market.

You don't need to own assets in order to profit from them.

Trade many different markets from just one account - Spread Betting provides people with the ability to trade many different markets from just one account - British shares, American shares, European shares, stock market indices, government bonds, exchange rates, gold, oil, index options, and of course sport and politics.

You can Limit your Losses by placing 'Stops' on your account - stop loss orders can even be 'guaranteed' to be executed at a price you stipulate in advance, in fact a stop loss order set with a spread betting firm does not depend on a physical order being put through the underlying cash market and in this respect execution of stop loss orders is better than with ordinary stock brokers

Less paperwork is involved compared to conventional share dealing. - setting up a spreadbetting account is simple and quick, all that is required in most cases is a signed application and utility bill.

Spread betting makes it easier to track your investments - if share X is up 15 points on the day, it is far easier to estimate your profit by calculating that you have made a £10 per point increase than calculating your number of shares, say 12,500 multiplied by 15 points, less broker charges, stamp duty, tax and so on...

Online trading platforms for spread betting are often said to be more advanced compared to those to traditional share dealing. Most spread betting firms nowadays also offer their clients extra features like sophisticated charting packages and economic data free of charge.

Virtual trading platform are sometimes available - some spread betting companies offer a virtual trading platform for you to practice on. This offers an opportunity for potential spread bettors to understand the market, the dealing process and test trading strategies before committing real money. The ability to practice with virtual money helps reduce the risk of entering into incorrect postions and helps novices to understand the risk involved in dealing with geared products.

Innovation and flexibility (binary betting comes to mind) - Another major advantage that the spread betting companies have over the more traditional firms in the financial markets is that they can offer new products or variations on established products very quickly. Because their products are so called Over-The-Counter (OTC) they don't have to go through the regularity process that major Exchanges do. All financial spread betting companies are however fully regulated by the Financial Services Authority (FSA).

Regulation by the FSA comes with the peace of mind of knowing that you have a legal right to your winnings.

Working from home means that your lifestyle is flexible and you are your own boss - (although we recommend having secondary sources of income).