A: Spread betting providers make money in a variety of ways. Spread betting brokers make the most of their money from the spread; they typically add a small margin above the usual market spread, so a share priced at 100p to sell and 102p to buy might be 99p to sell and 103p to buy via a spread bet. For instance as I'm writing the spread around the underlying bid and offer of Vodafone is a total of 20 basis points (0.2 of 1 percent). The spread means that at any given time, the price that you can buy at is always higher than the price you can sell at. This also means that the provider makes a profit from the spread whether you win or lose.
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Your spread bet does not affect the share price of vodafone as it is a contract between yourself and the spread betting provider. So, if you go long by 10 pounds a penny the provider is effectively short 10 pounds. Bear in mind that there may be thousands of trades in vodafone throughout the day so the provider's overall position may be constantly changing. Depending on the nature and overall size of the provider's 'book' they may also hedge their exposure independently - which could take the form of buying or selling shares on an exchange. However, the fact is that if a spread betting firm doesn't hedge your bet in the wider market then they win when you lose and lose when you win.
Also note that for a stock like vodafone there is plenty of liquidity but for others there may be very little so a provider may potentially offer a limited size in which to trade. Many illiquid stocks (in the open market) have a number of market makers that offer prices, but again, only in a certain size (normal market size - NMS). The normal rule of thumb would be that the provider is able to offer the equivalent as a spread bet so that that they can cover that bet fully (and not over-expose themselves).
And they also charge you financing on your open spread bets (currently about 5% a year) - this either takes the form of a daily financing charge or by adjusting the price of your bet. Of course they will also make money on the interest generated on unencumbered funds...and all these charges taken together do add up so it is imperative that you shop around for the best combination of spreads, margin and financing rates.
Perhaps the right question to ask is: How do spread betting providers NOT make money?
The December 2009 trading update from London Capital Group provided some interesting insights into their business model. The shares of LCG took a battering after the group posted a profit warning. This is interesting in that London Capital Group are becoming a sizable player in the spread betting industry operating both their own brands (ProSpreads and CapitalSpreads) as well as a number of major white-label partners including: Paddy Power Trader, TradeFair and SaxoSpreads.
Reading from the trading update, a number of interesting factors contributed to the profit warning that I think spreadbetters would find interesting:
-> 1) Development of these white label partner sites is turning out to be costly.
-> 2) Spread betters are winning more. Which of course is good news for us. This seems to imply that when the market is stable (i.e. relatively predictable), and with the markets in a general upward direction since March 2009 (to December 2009) it becomes easier for punters to come out on top. 'Less volatility means that people are more confident about sitting on their positions when the market goes the other way,' on analyst from the Finanical Times was quoted as saying. Thus less people close out their losing positions, which is how spread betting providers make large portions of their monies.
However, I believe the volatility witnessed since the Dubai debt troubles, coupled with the present economic climate, things may soon get interesting again which can only benefit the likes of LCG.
A: The bid-offer spreads for individual stocks are calculated as a percentage of the stock price. The main factor affecting the percentage is the liquidity in the market. If there is a wide spread in the underlying market (exchange) where your spread betting provider may hedge your trade, this will be reflected in the spread that the bookie quotes.
For instance Capital Spreads quotes -:
UK Shares: 0.1% either side
US Shares: 0.1% either side
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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