Buying Stocks vs Spread Betting vs Spread Trading & MIFID

Q. I thought that whether trading or spread betting one is exposed to currency fluctuations in the same way?

After being interested in going long on wheat…etc for a while but thinking I would have to jump through some hoops to do so I now discover that I can bet on ETFS Wheat via IG Index or I can buy ETFS Wheat via my Selftrade account.

One thing that I'm not sure of though. On my Selftrade watchlist it tells me that the price is in dollars and gives me the GBP conversion. Am I right in thinking that this implies that any purchases made are subject to the USD/GBP exchange rate as opposed to IG index when one is simply betting on the dollar price and so exchange rate does not come into it?

Can you explain the implications of this in simple terms? Is there a way to differentiate between the effect of the rising value of wheat and the falling value of the dollar? Do the two methods of trading result in slightly different exposure to the commodity itself and the currency it is traded in?

A: Not so, if you physically buy the Exchange Traded Fund (ETF) then your sterling profit/loss will relate to the change in the sterling price of the commodity (if the dollar drops by 5% and wheat rises by 5% then the sterling price remains unchanged). Just so for the ETF you've bought - it's worth more dollars each of which is less valuable to you). Whereas if you bet with IG Index, then, if you win the provider will payout (in sterling) according to what you're betting on, which is the dollar value of the ETF (and hence the commodity).

If you buy the ETFS Wheat with your Selftrade account you would be trading in dollars. The exchange rate implication depends on how long you stay in the trade and what happens to the exchange rate but it does not stop there! How other countries currency rate varies to the dollar also affects their trading in the base commodity itself. For example, if they can buy more wheat in their base currency due to a favourable USD exchange rate, then the commodity demand will probably increase. There has been a certain amount of this type of activity in the Asian markets recently due to the high price volatility which has helped in maintaining the wheat price on the drops.

I have found that for my short term trading the £/$ exchange rate only has a minimal effect over the 2 or 3 weeks of my trades. If you always keep a note of the daily exchange rate you should develop a feel for the currency ebb and flow. By contrast, the short / leveraged ETFs do have some forex exposure; the short ETFs are long USD and short the commodity, and the leveraged ETFs are short USD and doubly long the commodity.

You are stuck with this fact however if you trade for $ based commodities but it does help to make the markets more interesting as well as sorting the wheat from the chaff so to speak. The best thing is probably to give it a go with a small amount of cash and see how you get on.

Q. Can I buy a spread bet as a substitute to a shares holding?

A: Yes, this is best explained by an example -:

If the daily bet on Barclays Bank shares was being quoted at 736-738 points, a bullish investor who thought that the price was going to rise would buy the spread at 738. Each point is defined as a one pence move in the share price, so a bet of £10 (1000p) a point would be the equivalent of buying 1,000 shares.

The logic behind £10 a point equating to 1,000 shares is that for each share one point means one penny. Therefore, there are 1,000 pennies in £10 and therefore through my calculations 1,000 pennies equals 1,000 shares.

If the price were to rise to 760-762, the position could be closed by selling the spread for £10 a point at 760. This would produce a profit of 22 points or £220.

Q. What are the differences between buying stocks versus betting on them?

Having been reading about buying stocks versus betting on them, I still can't figure out any advantages of really buying the stocks...

A: I can think of 3 key differences offhand. There are many others.

Shares are assets. As such they can be used as collateral against other financial instruments. For example, if I want a buy to let mortgage in the UK or some other country, shares provide evidence to the lender of my credit-worthiness independent of salary. They can also be used as security on other financial instruments (like options, which I'm studying at the moment). A spread bet on the other hand implies no ownership, you simply gain on the difference of the share price.
Shares provide a dividend. Look at the tactic of buying shares before the ex-dividend date (say 6 weeks before), which allows you to benefit from a small (taxable) income without needing to sell your shares.
The spread on spread betting is often greatly inferior to the market price of the shares. This is heightened by the liquidity of the stock (for example in small caps) or by the spreadbetting company's need to hedge their risk For example, 'everyone' thinks Barclays share price will fall. So the buy price (December) will be very close to the actual share price, but the sell price might be well below current market price. i.e. The price needs to go down a lot before you can break even on your bet. This was the case with insurance stocks about a month ago: with Provident being 8 pence below the current sell price, making it quite unattractive to short.

We look into more detail into the differences between Spread Betting Versus Trading here.

Q. Is spread trading the same as spread betting?

A: Not really although in the UK they tend to sometimes refer to 'spread betting' as 'spread trading' (i.e. interchange the terms so as to remove the betting word connotation) which may obfuscate those who are not familiar with spread betting in the UK.

In reality though spread betting and spread trading are very different. Spread betting is not regulated by the exchange as such. It is more like the Forex market. You are betting if a single market is moving up or down (same as buying or selling stocks for example).

Futures Spread trading is buying and selling contracts at the same time (for instance buying December wheat and selling July wheat) and to take advantage of all these combinations. For example, a spreader might take the risk of the difference in price between March wheat and July wheat, or the difference in price between December Kansas City wheat and December Chicago wheat. Spread trading as opposed to spread betting generally refers to trading futures spreads. Because of the hedge inherent in the nature of the spread trade margin requirements are usually significantly lower for spread trades than for the outright futures contracts.

The subject of this website is not spread trading but spread betting but you can read more information on spread trading here (pdf format) and here. (pdf format).

Q. What is MiFID and what are its objectives?

A: MiFID is an acronym for the Markets in Financial Instruments Directive (2004/39/EY), part of the EU Commission Financial Services Action Plan which seeks to create a single market in financial services for the Union. The scope of this directive is to harmonise practices in national securities markets by facilitating provision of investment services across borders and by removing barriers to trading whilst boosting investor protection and strengthening confidence in the market.

Investors from all European Union countries will now get access to information on the service provider, choice of financial services, instruments and underlying risks, costs, safekeeping of clients funds, execution of orders and management of conflicts of interest. Moreover investors are requested to provide more detailed information about their investment experience, financial position and investment objectives/knowledge.

Q. What are the implications of the Markets in Financial Instruments Directive and how does this affect you?

A: In November 2007, the activity of spread betting providers, like every financial institution in the UK came under a new European Directive - the Markets in Financial Instruments Directive (MIFID). This is the first time that European legislation covered commodity derivatives, credit derivatives and financial contracts for differences (which is what spread betting essentially is...)

Under the directive spread betting companies will be tied to offer best execution meaning that companies cannot make their own prices for shares. This means that the spread will be fixed and the price offered to you must be the best price possible in the underlying market. With this we will probably also see the end of skewed spreads when markets are moving in a particular direction. Also, it will be very difficult for spread betting companies to widen spreads to balance their book and they won't be able to move spreads if they have an opinion that the markets are likely to move in one direction.

Not only that but any EU based company to be able to acquire a license to trade they now have to possess a pretty large balance sheet since they are a securities ISSUER. This amount used to be fixed but post MiFID last year, it's more or less negotiated with the regulator like the Financial Services Authority. Compare: Pre-MiFID a traditional agency-broker needed about 1/3 the balance sheet of a CFD/spread house. So a lot more room to be bucket-shoppy. Just check out the bankruptcy of Pacific Continental Securities which went to the wall.

Lastly, the new directive puts the onus on the provider to judge whether you are sufficiently experienced and understand what you are trading - this is the reason that almost all companies have launched trading academies. This implies that providers are likely to be more careful about their customers and what they allow them to trade - and you will have to prove to the provider that you are competent! So although the MIFID is primarily intended to protect the unwary it is also putting increasing pressure on spread betting companies which might in turn limit your choices.

As the MIFID directive applies across the whole of Europe, bookmakers are busy opening up branches to tap these markets (IG Index has just opened a branch in Spain and another in France for instance) - and note that binary betting does not fall under the Markets in Financial Instruments Directive.

Q. What do you think of telephone trading? Sometimes my online orders are getting rejected...

A: In most instances the markets move so quickly that phone trading is not viable IMHO. I rarely have problems with spread betting providers accepting orders online.

For instance I rarely have a problem with City Index accepting an order online. If using a decent (low latency) connection 99% of orders get filled at the price displayed when you click. The other 1% get rejected if the market moves. Using the mobile trader application on a mobile phone may lead to an increase in rejection incidents - but that's understandable. I don't think anyone can feel it's 'unfair' if the dealer rejects an order because you're using a connection with so much latency that the market moved away from the price you were originallyquoted.

Keep in mind that most providers are targeted to retail individuals and they probably don't like you using phones to take up dealer time, some even charge extra or not allow it. They would also have to be open to kind treatment per the FSA's Treating Customer's Fairly principle meaning that all clients (be it a small punter or hedge fund manager) would be offered the same level of service.

Of course if you are not intraday trading and taking on a position for some months intraday volatility is less relevant in this context and placing a bet on the telephone would work fine.

Note: Never phone for a quote and tell the dealer what you want to do, for instance do not phone up and say, 'I want to sell GBP50 per point, can I have a price?' - just ask for a price

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...Continues here - Market Gaps and Stop Losses

Hope that answers some of your questions but feel free to send me queries, comments or concerns at traderATfinancial-spread-betting.com or by filling in the form below :-)

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