Spread Betting Versus CFDs

Q. How do spreadbets and DMA compare to each other?


A: With a spread bet you never physically buy or sell an instrument (i.e. a share in Barclays or gold bullion), you simply bet on the direction in which you think the instrument will move. This means that you 'buy' if you think the price of, say gold, is set to rise and 'sell' if you think the price will drop. The degree to which you are correct dictates how much you win or lose. Spread betting with a broker means that all your profits are absolutely free from UK capital gains tax*. You do not have to pay a broker's fee or commission charge and there is no stamp duty to worry about when you open or close your bet. The only charge is the provider's dealing spread.

DMA technology allows more experienced traders Direct Market Access (DMA). As a DMA trader, you can set your own price and deal directly with other market participants. This can help minimize the cost of the bid/offer spread on your trading, and can even work in your favour if you have an order to buy that is filled at the Bid Price or an order to sell that is filled at the Bid Price or an order to sell that is filled at the Offer Price. Greater transparency allows you to consider market liquidity when placing a trade and will very often ensure that your trades are executed at the price you choose. This will allow you to avoid having your orders rejected. Of course, nothing in life is free and trades on shares using DMA will incur commissions if you deal CFDs with or without DMA and you will also have to pay capital gains tax on any profits.

The gap between Direct Market Access and spread betting has narrowed in the last few years in particular the bid-offer spreads which have narrowed sharply and margins; to the extent that some smaller providers utilize other spread betting firms to hedge their exposure instead of taking positions on the underlying directly.

Q. Are there any advantages to using Spread Betting to trade as opposed to Direct Market Access?

A: The advantages of spread betting over DMA are that any profits made whilst spread betting are currently exempt from capital gains tax for UK and Irish residents.

With DMA you are trading the current market price and are charged a commission on top. With spread betting the tradable price includes the charge as added spread.

If you were a short term trader who had limited capital to trade with, than spread betting would definitely be the better alternative to using DMA because:

-> There are no broker charges or commissions to pay.
-> The minimum trade size is smaller.
-> Under current UK tax laws spread betting is tax free.
-> There are no monthly subscription fees to pay for a spread betting platform, DMA platforms and data feeds can sometimes carry a fee or require that you make a certain number of trades per month.
-> You can gain access to a wider range of markets all from one platform.

As regards the disadvantages there are not many disadvantages of spread betting over using DMA and that's why statistically most traders in the UK and Ireland use spread betting platforms to trade rather than CFDs. The only disadvantages are:

-> DMA allows you to trade at the market price.
-> Better market transparency, you can see the order book and the volume of trades going thought the market.

For example on FTSE 100 shares the spread betting company might add 0.1% to the offer and subtract 0.1% from the bid of the underlying stock. With index, FX, bond, interest rate and commodity products most spread betting providers have a constant spread, for example the FTSE 100 index spread at Capital Spreads is 1 point.

Most direct market access brokers will quote you what they tell you is a 'raw spread' and then apply volume commissions on top. These volume commissions are a cost to you the same way the spread is and you have to understand your costs in order to compare dma to non-dma. For example, taking a £200 per point trade on GBP/USD is a deal size of £3.38M. If the DMA broker charges you $15 per million USD traded this will mean you have to pay brokerage fees of $85 (£3.38m * 1.69 = $5.71m).

That $15 per million $ traded on a GBP/USD trade is equivalent to 0.25 pips per leg ($15 * 1.69) per million £ of notional, which is an extra 0.5 pips spread round turn on your GBP/USD trade. If the GBP/USD DMA spread is 1.0 your all-in cost is 1.5 pips. that's the number you need to use for your comparison.

Of course it would be great if everyone could trade via direct market access in all the markets that spread betting providers offer for free. But access to DMA on futures usually costs $$$ plus the margins on equity, commodities, indices...etc are huge compared to spread betting offerings and the size of most contracts puts them out-of-reach of many retail clients. For instance, the Dax contract is the equivalent of a £22 bet and the initial margin required by brokers is over €15,000. (a far cry from the usual £1 and £50 pound minimum margin requirements required by a spread betting outfit). Personally, for example, I don't like to trade FTSE future (Z-future) which carries too high a stake for my liking, in this case we have the opportunity to trade the FTSE rolling daily, which is an good choice for trading a specific market.

 ...Continues here - Using Options as a Hedging Tool

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