Using Spread Betting for Hedging Purposes...

Q. How can I use spread betting to hedge my portfolio?


A: A way to hedge against falling markets is to sell risky assets and buy into assets that are considered 'safer' by the markets. Spread betting allows you one step further; it empowers you to open short positions and profit from a market decline which is why it can be useful as a hedging mechanism. In practice you can short-sell part or all of your portfolio using spreadbets, and by doing so you are effectively hedging your shares portfolio should its value decrease as markets fall.

For instance, let's assume that you hold £5000 worth of shares in Barclays, but you are worried that persistent uncertainty may lead to further falls in its share price. You can short sell £5000 worth of Barclays shares using a spread bet. If Barclays shares continue to fall, then any losses incurred in your physical portfolio would be offset by the increase in value of your spread betting position. In a nutshell this is the essence of hedging: a position cancelling out the other.

Q. I'm looking for specific examples where one can use spread betting as a hedge?

I know how hedging works. I'm looking for a specific example, and why spreadbetting and not a corresponding market: 'If it can hedge efficiently...'

A: Yes, despite spreadbets having a reputation as a speculators' tools, you can also use spread bets to reduce short-term risk. There are a number of possibilities really...

  1. Suppose you are worried about a market downturn and you have a £16,500 holding in a number of FTSE 100 shares. Selling your shares in anticipation of a drop is one way of doing it. However, this means you will be trying to time the sale and subsequent re-purchase (assuming you really want to be in the shares long term). This also has potential tax implications as it risks a tax bill on the sale; capital gains tax may be applicable for instance, not to mention broker dealing fees and stamp duty on the re-purchase. If you hold a diverse range of FTSE 100 blue chip stocks and you are expecting a market downturn but don't want to sell your holdings, an alternative would be to sell a FTSE 100 spreadbet while retaining your shares. You can keep the spreadbet position open for several months if needs be, or until you think the stockmarket is about to stop falling. Taking our example; with the FTSE at 5500 this would be technically equivalent to £3 per point on the FTSE. If the index fell 300 points you would lose £600 on your £16,500 shareholdings. You could hold on to your portfolio and wait for the market jitters to pass or if you are feeling particularly bearish you could exit the market (which would incur dealing costs). Alternatively, you could sell the FTSE at £3 per point with a spread betting firm to hedge potential losses - any losses on your shareholdings would then be offset by profits made from the spread bet.
  2. Similarly, let's suppose you have a big shareholding in Vodafone. You believe that the next trading update will be below expectations, and you would like to take advantage of this - yet on a longer timescale you still would like to continue holding the shares. You don't want to have to sell and re-buy your shares (which would incur stamp duty on the repurchase plus commissions and in some cases even a CGT bill on the disposal). So instead, you could keep holding the shares while going short on Vodafone using a spreadbet. In the eventuality that Vodafone drops, you'll stand to make a tax-free gain on the spread bet when you later close it at the lower price, and not having to worry about churning your Vodafone shares.
  3. Let's say you are planning to buy a number of FTSE 100 shares in two months' time when you will be receiving a nice some of money out of the sale of a property. However, the FTSE is on an uptrend and rising fast and you are worried that if you wait two months before buying, you'll have to pay substantially more. This is where a spread bet can come in useful. You could go long on the FTSE now so that if the index rises over the next two months, you stand to gain from the bet when you close it out which helps to offset the additional cost of having to pay a higher price for the shares in two months time.
  4. You are planning to go to the USA on a family holiday in a few months time and the pound is currently in a strong position against the dollar. You believe that Sterling is too strong and is unlikely to hold ground to the dollar until you depart but you don't want to tie up your cash by purchasing the currency early. You see a spread of 1.7984-1.7992 on a spread bet which is due to expire just before your trip and sell at £4 per 0.0001 movement. Your prediction is proved correct and a month later the dollar strengthens against the pound and the firm puts out a new spread of 1.7842-1.7850. You close out the bet by buying at the new price of 1.7850 and make a profit of £536 (1.7984 - 1.7850 = 0.0134 x 4 = 0.0536). Of course, if Sterling had risen against the dollar, against your expectations, and had expired at 1.8008 you would have lost £96 (1.7984 - 1.8008 = 0.0024 x 4 = 0.0096).
  5. You own 50000 shares in Vodafone and don't want to sell them and use up your tax allowance until the following tax year. You then sell £500pp of VOD through a spreadbetting firm and you have got out at the current market price and not paid any stamp duty or tax.
  6. Similarly let's assume the end of the tax year is nearing (5 April) but you have yet to utilise the annual capital gains tax allowance. Under the original 'bed and breakfasting' regulations you could sell your FTSE 100 shares via your broker just before the end of the tax year, and then proceed to buy them back just after to materialise a gain that could be used for the Capital Gains Tax allowance. However, the rules have now changed and you are required to complete your sale more than 30 days before the end of the tax year. This is a long period to stay out of your shares hoping they don't rise. A way to hedge against this is to buy a FTSE 100 spreadbet just after you sell your shares so that if the index rises while you are waiting to buyback your shares, you'll make a tax free gain on the bet.
  7. Your American father recently passed away and he left you $1,000,000 in his will but you won't get the cash until March. You then lock in a March forward contract to protect yourself from any adverse price movements in the forex currency exchange rate thereby locking in the current rate.
  8. To secure a rate or price in the future - example - I know I need to buy some Gold bullion in December for my Jewellery business, I can hedge the risk with a Gold future and be certain that I won't have to pay more than $830 per oz.
  9. You are a farmer growing a crop of wheat/corn which will not be ready until June so you lock in a price now.
  10. Arbitrage. Occassionally you might see different spread betting firms quoting different non-overlapping prices for the same bet/market. This especially happens with the less popular markets such as political/sports bets. For instance if you have one quote at 220 - 250 from one spread trading provider whilst another is quoting this market at 260 - 300; you could go long with the first provider at 250 and sell with the other provider at 260. Such arbitrage opportunities provide the possibility to extract a profit whatever the outcome of the event.

Q. I'm thinking of investing €10k in Irish shares, mainly some of the banks. I have read that I can hedge this somewhat by spreadbetting with a bookie....

How does this work in practice? How much would I have to risk to protect my investment from a 10% drop?

A: If you bought €10k of Bank of Ireland at €9.30 you would have 1075 shares. If you subsequently initiated a short spread bet on Bank of Ireland, betting €10.75 on each cent of decline in share price, you will be left hedged.

Price rises to €9.50, stock is worth €10,212.5 but you owe €215 on your spread betting account. Price drops to €9.10, stock is worth €9,782.5 but you are up €215 on your spread betting account.

While you have these two opposite positions on, you aren't affected by price movements, but you lose out on charges. Realistically, doing this makes sense only if, you are putting in the hedge for short periods of time, otherwise don't buy the stock in the first place. Typically you would have to post 10% margin on the spreadbet.

Another reason to do this would be tax based, ie. you bought AIB shares at €4, you think they are going to drop but if you sell then you have to realise your tax liability, and you want to buy them again. By hedging with the spreadbet you lock in the value of your position without paying the tax, removing the hedge when you think they will go back up.

 ...Continues here - Hedging the Sterling against the Dollar or Euro

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