Why is it called Spread Betting?

Q: Why is it called Spread Betting?


A: The term spread betting is used because there is an additional spread around the market price (they make their money on the spread, hence the word) and the reason it is called a bet is because if that term is used it means you are exempt from all capital gains taxes!

Spreadbetting providers don't charge actual commissions regardless of the product you are trading, this in order for the trade to qualify as a bet. They make money by posting larger bid/offer spreads than the underlying market.

Bid-to-offer spreads are common in most financial markets. You come across them when you buy stocks, bonds, ETFs, currencies and of course every time you open, or close, a spread betting position. The 'spread' is the difference between the current price market participants will give you if you sell the stock (aka as the Bid price) and how much they'll charge you if you want to buy (aka as the Ask price).

In spread betting the difference between the bid and ask price is a little bit larger as prices are derived from the underlying stock's regular bid/ask spread plus a little extra constituting the provider's rake. This provider's slightly wider bid-offer spread is usually more than compensated for by not having to pay capital gains tax, stamp duty, or income tax on dividends on your spread betting dealings...

So just remember that with spread betting you are betting on the price rising above the spread or falling below the spread. At any given time you will always have to buy at a higher price than you can sell at.

Q: What is a spread?

A: The term 'spread' derives from the fact that traders suffer a bid-to-offer spread (the gap between the buy and sell price) although there are no other transaction fees or taxes. Bid-offer spreads are familiar to investors who trade shares, but unlike conventional share dealing there are no extra costs involved such as stamp duty, broker commissions and administration charges. But what actually is a spread? A spread is the difference between the price your spread betting provider will sell to you, and the price the provider will buy from you. With financial spread betting, all the fees and trading costs are wrapped inside the spread, so calculating your profit or loss on a trade is fairly straightforward. As an example, the typical spread on the FTSE daily rolling contract may be quoted as 5010 to 5012 representing two-point spread. You would 'sell' (go short / 'down bet') at 5010 or 'buy' (go long / 'up bet') at 5012.

⇑ ⇑ ⇑ ⇑ Listen to our Overview of Financial Spread Betting.

The explanation text that follows is intended to help you understand the points referenced in the podcast above.

FTSE 100 index trading at 5772 - 5773
You decide to buy (i.e. go long) at 5773
FTSE 100 index risen by 10pts to 5782 - 5783 : Profit = 9pts x £1 stake
FTSE 100 index fallen by 10pts to 5762 - 5763 : Loss = 11pts x £1 stake

So what is the 'spread'?

The spread denotes the difference between the price you can buy at and the price you can sell at. You would buy (go 'long') at the higher price if you think the market will rise, or sell (go 'short') at the lower price if you think it will fall. So in other words a bid/offer spread (also referred to as a sell/buy spread) represents the difference between the prices at which you can purchase and sell spread bets.

As a spread bettor, you would naturally want the difference between the buy and sell prices - the 'spread' - to be as tight as possible, so the market does not have to move far before you are in profit. Spread betting providers will often be heard referring to their 'tighter spreads', which simply amounts to lower charges.

If the prevailing market price for silver is 18.75/85, the spread would amount to 18.85 - 18.75 = 0.10 (10 points) with the mid-price (18.80) usually being the prevailing market price. If you decided to go long at 18.85 you would not actually start making money from 18.80 (current market price) but will do so after the stock price has gone past 18.85. The difference in points between the bid and offer spread is the cost of executing that particular trade and is where the spread betting company makes its money.

So what is the 'spread'? Courtesy of IG Index

Demonstrating how the spread works for different bet closing prices when buying or selling £1

Always remember that a buyer opens a position by taking the price on the right of the bid-offer spread - the provider's 'offer' price. A seller, betting on a fall in an asset's price, would enter a trade at the price on the left - the provider's 'bid' price.

Spread sizes vary by market depending on -:
  1. the liquidity of the underlying market (i.e. the number of trades being transacted in a share in a given time period).
  2. the volatility of the underlying market (i.e. how large the price fluctuations have been historically over a given time period).
  3. the amount of freely traded shares that exist for the relevant underlying instrument.
  4. competition from other providers (i.e. the more providers are quoting a market, then the tighter the spreads will be).

We would thus expect shares or markets with high volatility, that trade infrequently and that are not widely quoted to have larger bid-ask spreads. In general, the more popular the asset being traded, the narrower the spread when you open a spread bet and the better your possibilities of making money. This is because the higher the volume in an asset, the more likely the provider will be able to hedge its risks and flatten out its position with relative ease, so the price charged for providing its service will be less resulting in a narrower bid-ask spread.

The workings of spread betting are very easy to understand. You simply have to go higher (long) or lower (short) than a price the bookie gives you. For instance, how many jelly beans fill in a one-litre bottle? If the spread betting provider offered a 240 to 250 range and you thought there were more than 250 you could go high (this is referred to as going long). On the other hand if you believed there were less than 240 you would go low (this is referred to as going short). To bet real cash you have to bet a certain amount per unit on the number of units in the bottle - the units in this case would be beans so if you went long at 250 at say £5 per unit and it later resulted that there were 280 in the bottle you would have been right by 30 beans. At £5 per bean you would win £150. Of course the opposite is also true and if there were just 230 beans in the bottle you would have been wrong by 20 beans implying a loss of £100

Q: How much does it normally cost to make a trade?

A: The cost is a) in the spread and b) the financing charges (usually 2% to 3% over the Libor rate) for holding overnight rolling positions.

What is the Spread?

The spread betting company takes the prices of the various shares from the underlying markets and adds a little extra to the bid-offer spread. There is no additional commission or stamp duty so this represents the only cost of trade with any gains being tax-free. The spread also helps to compensate the provider for the risk involved in accepting the trade. All bets are normally in pounds per point so the exposure and any gains are all in sterling.

So to conclude deals don't suffer a fixed commission as they would when trading shares, but you 'pay' the bid-ask spread. i.e. if for example let's say you are betting on the FTSE index and you can buy it at 3800 or sell it at 3801. The 1 pt difference is the margin and where the spread betting firms make their money. See also How do spread betting companies make money?

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