Financial Spread Betting - A World of Opportunity - Part 1

To the casual observer, the smartly suited City-based stockbroker has little in common with the scruffy bookmakers who ply their trade on racecourses around the country. But a closer look reveals that these very traditional professions are remarkably similar. Both essentially exist to enable customers to gamble on their views - well-researched or otherwise - about the prospects for a particular asset, whether it is bloodstock, or just stock.

Today the choice of bettable events is enormous. You can take a position in the share price of major companies in the UK, US and Europe, and in indices, interest rates, commodities and currencies. Commodities are especially difficult and expensive to access in other ways, but you can spread bet on a range of commodities including precious metals, Brent crude, cocoa, orange juice and pork bellies. You can also bet on stock market sectors such as Oil and gas or Media and photography. Until last October (2004) several companies also offered spread on house price based on the Halifax house price index, but so many investors predicted a drop that firms such as IG Index shut their doors to new housing bets. There are often topical bets for fun. During Euro 2004, for instance, Finspread ran football themed bets such as 'Football's coming home', a bet on the difference between the FTSE and the Dax until either England or Germany were knocked out. The current emphasis is on the elections.

Moreover, the small, but growing, number of firms which specialise in financial spread betting are blurring the divide between broker and bookie. All the spread betting bookmakers are now targeting customers of execution-only stockbrokers in a bid to grow their businesses. Investors will find few stockbrokers happy to take bets on the 2.15 at Epsom but several bookies will accept gambles on the FTSE 100 index, or on any number of other financial markets.

In fact, financial spread betting (see the explanation below for how it works) offers a number of advantages over traditional broking. First, it enables investors to trade in both bull and bear markets. Through a stockbroker, the only way to bet on the market - or an individual currency, commodity or stock - falling is to go into the complicated and expensive derivatives markets. With spread betting, selling short is as simple as backing an asset to rise in value.

Moreover, financial spread betting is often less expensive than dealing through a stockbroker. Brokers charge a trading commission and 0.5 per cent stamp duty is payable on all share purchases. In contrast, the only charge for spread betting is the spread which bookmakers make between the buy and sell prices on bets. Equally, investors have to pay capital gains tax on trading profits above their annual CGT allowance - £7,100 in the 1999-2000 tax year. But all spread betting profits are tax-free - in the eyes of the Inland Revenue, spread betting is gambling rather than investing so gambling duty, rather than CGT, is payable. The spread quoted by the bookie includes a sum to cover this cost. Nevertheless, many investors still find it difficult to think of spread betting firms as respectable City intermediaries. 'Spread betting isn't complicated but people are wary of us,' says Sandy Campbell of IG Index. 'This isn't betting, it's an alternative form of investment trading and once people have made the transition from dealing through a broker, they rarely go back,' she argues.

The Origins

IG is the oldest bookie in the spread betting business. It was originally set up in 1974 for investors who wanted to speculate on the gold market but were being stymied by the UK's exchange controls. It soon moved into spread betting in a range of financial markets and in sport. 'People do like the fact that they're dealing with a firm that has been doing this for many years,' says Campbell. However, IG's main rival, City Index, which was launched in the 1980s, now claims to have a larger annual turnover than IG. 'We're not confrontational - we don't take the punter on,' says City Index marketing director David Buik. 'We lay off every bet we take in the futures market so we can give customers tighter spreads,' he explains.

There is no such thing as easy money. In reality all profits are a factor of work, be it risk or actual labour. If you are just starting out bet very small and measure the results. Betting with real money however small is different from doing it on paper. However, if you bet too big, random market swings will blow you out of the game. This is called 'gamblers ruin'. If you bet too big you will always lose even if you are generally right. Spread bet are leveraged but you should avoid using too much of this leverage on any one single bet.

Both IG and City pitch to the high-quality end of the market with relatively high minimum deal sizes. IG will not accept bets much smaller than £5-£10 per point, though its subsidiary, Index Direct, has lower minimums. City's smallest bet is £5 per point, except for gambles on a few very large shares. In contrast, Financial Spreads, the financial spread betting arm of sports gambling specialist Sporting Index, has been targeting the smaller end of the market since its launch earlier this year. Its customers bet as little as 50p per point. Chief executive Lindsay McNeile says he wants to extend the reach of financial spread betting: 'Spread betting on financials is very serious - there are large risks - but it is also fun.'

Financial Spreads offers similar services to IG and City, but also has more light-hearted bets. One popular gamble is on the number of stocks in the FTSE 100 which will finish the day up or down. Investors who bet a pound a point over the course of a day on this gamble have a limited downside -£100 at worst. McNeile argues: 'The professional investors will find us because spread betting is now part of their toolkit. But for small investors, £10 a point, say, is a chunky bet. It's rare now for the Footsie to move less than 50 points in a day - that's a £500 swing.' However, Buik thinks Financial Spreads has taken a risky approach. 'They are sucking people into spread betting who can't afford it and don't understand it,' he warns. Buik says City is keen to attract only the more sophisticated customers. 'This market can bite your bum,' he says.

Even so, Buik accepts that financial spread betting is becoming more popular with all sorts of investors. He says: 'A year or two ago I felt that this was an excellent market that only a few spivs in the City knew about. But business is taking off.' New entrants should help spread betting expand.

While IG and City had the financial end of the market to themselves for 15 years, Financial Spreads has been a serious competitor since its launch in April. And Victor Chandler, the controversial Gibraltar-based bookmaker, launched spread betting on sport in early August and a spokesperson says financial spread betting will follow.

A World of Opportunity

The range of trades available through financial spread betting has also mushroomed over the last two years. IG, for example, now offers spread betting on around 40 global stock market indices, 15 currencies, 40 commodities and 40 options contracts. Investors can also bet on the individual share prices of the largest 350 companies in the UK. In addition, IG, City and Financial Spreads all offer limited downside betting, allowing investors to specify how much they are prepared to lose on any bet. Once a bet is laid, the firm will automatically close out your gamble if the market moves against you by more than a pre-determined amount. This risk management service costs a little extra, but is a useful facility given the potential for large losses in spread betting. IG Index's Sandy Campbell expects financial spread betting's next phase of expansion to be over the Internet. The firm is alone in offering on-line spread betting, though City says it is planning a rival service. IG's Internet site has been very successful, Campbell says, with 25 per cent of the company's turnover coming from electronic bets. Spread betting is well-suited to the Internet; it is basically a short-term exercise. Indeed, Angela Knight, chief executive of Apcims, the retail stockbrokers' trade body, says this is why she is unconcerned by spread betting firms' attempts to steal clients from her members. She argues: 'Spread betting is like day trading - though both are fashionable today, they really have nothing to do with long-term investment in a company.' Knight is correct in that spread betting is an inefficient long-term way of backing a company. Gamblers do not benefit from the dividend income companies pay their shareholders. Also, most bookies will not let investors speculate more than six months in advance - there is a small sum to pay to roll over the gamble for another six months. Nevertheless, spread betting is not simply for short-term gamblers.

Spread betting can be a useful tax planning tool and is ideal for investors who want to hedge the risks they face on their actual portfolios. Imagine, for example, an investor with a large portfolio of shares who is convinced that the market is about to collapse. One option would be to sell his portfolio and move into cash, but this might trigger a sizeable capital gains tax bill. The alternative is to sell points on the Footsie or the All-Share with a spread betting firm. If the investor's view is right, his portfolio losses will be matched by gains in his spread betting account.

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