Spread Betting Versus CFDs

Q. Are CFDs and Spread Betting the same thing?


A: They are nearly the same with some differences. In fact there are many similarities between CFDs and spread bets. Importantly, they are both margined products, offering leveraged exposure to the underlying share or index. Because no ownership of the underlying share is conferred, neither instrument attracts stamp duty.

Traditionally, spread bets were run on quarterly contracts but this is no longer the case due to the introduction of rolling daily contracts which roll forward from each day to the next and could (in theory) run on infinitely but it is really exactly the same - operates in exactly the same way as a contract for difference does.

Spread bets are just re-wrapped CFDs, or to be pedantic, noting that the spread bet was created in 1973 and the contract for difference in the late 80's it is weirdly the other way around, but that's dull semantics...

The main tangible difference between contracts for differences and spread bets is the tax on any gains made. The financing charges on both products are about the same. Contracts for Difference and Spread Bets also incur charges in different ways. CFDs which are based on individual shares incur commission costs in the similar way to shares that you may trade in an ISA or stockbroker account. Spread Bets do not attract commission; but instead the difference between the bid and offer price (the 'spread') is widened. This form of charge also applies to CFD indices, currencies, commodities and sectors. So with shares a CFD provider will usually charge a separate charge for commission (usually about 0.1% on each leg of the trade) while with a spread bet they will usually add a fixed mark-up to the underlying bid-offer spread.

Also, with Financial Spread Betting (FSB) you have to enter a 'Stake' per Point and with CFDs you enter the 'Size'. A client who wishes to open a contract for difference position would be quoted in the same way as if a normal shares purchase was taking place - i.e. buying '1000 Barclays CFDs' - with spread betting you are simply betting on the price movement of the share or index...etc measured in pounds per point of movement. So the equivalent trade here would be 'buy Barclays at £10 a point although the exposure is essentially the same.

So with both spread betting and CFDs:
  1. You bet on the price changes of a market
  2. You bet on the exact same financial markets
  3. You don't own anything (meaning you don't get charged stamp duty)
  4. Both products are tradable on margin.
  5. Are regulated by the FSA (in the UK)
With spread betting:
  1. It is commission free - a good thing
  2. The spread is often a little wider (especially with shares) - a bad thing
  3. With spread bets you have expiry dates (which you can roll over to a future settlement date).
But with CFD trading you:
  1. Pay capital gains tax (18 – 28% in the UK) on overall net gains over £9,000 - usally considered a bad thing
  2. With CFDs there is no time limit other than the cost of money i.e. the cost of holding the position open and the point at which it stops being economically viable to hold the CFD.

Spread bets are particularly convenient as they are all denominated in sterling, so there is no need to worry about any currency complications unlike contracts for difference where you are trading in the base currency of the market you are trading.

Depending on the provider you have the opportunity to trade the Cash or Future Markets. In financial spread betting, future contracts have an expiry date but you usually have the opportunity to 'roll' contracts when they expire, CFDs have no set expiry date and the same position can be held open indefinitely. CFDs have a tighter spread but you pay commission - spread bets have a wider spread but are tax free, this is the main headline difference. In practice, however, the daily spread bets at say, IG Index are pretty much the same product as a CFD at IG Markets. Market-to-Market at end of day to take account of daily interest with 0.10% commission wrapped into quote rather than billed separately.

The only discernible reason I can think of where CFDs offer clear benefits against spread betting is if you are hedging a physical stock position for a short period of time - if you make a gain on the physical stock for tax purposes, you can offset the loss on the CFD hedge. You cannot do this with spread betting as it is a tax free product. Of course if you expect to make losses from just out and out trading, CFDs are the better route as you can offset losses here against any other taxable gains made somewhere else. But if you expect to make a loss why trade in the first place.

FSB: you can trade with a smaller amount of money than CFDs. With spread bets you are a Private Client, whereas with CFDs you are an Intermediate so larger account opening hurdles. However, as I already stated the main difference is that spread betting is tax free while CFDs are not in the UK. (Read more about the similarities and differences between cfds and spread bets here). I personally go for spread betting, just because it simplifies matters.

Q. Is it better trade indexes on CFD or Spread bet?

A:I think here it is worth comparing the two sites run by IG Group in the UK. IG Index offers financial spread betting facilities across a range of stocks, stock indices, forex pairs, bonds, interest rates, commodities and ETFs. IG Markets offers CFD facilities across a range of shares, stock indices, currencies, bonds, interest rates, commodities and ETFs. Check out the bid-ask spreads - THEY'RE EXACTLY THE SAME. The main difference between these two instruments is their tax treatment - CFDs attract capital gains tax whereas spread betting is tax free under UK tax law (for the time being). AND YET, despite the fact that the counterparty risk is exactly the same, with both of the aforementioned entities being part of the same IG Group, individual investors seem to have an aversion to spread betting due to the gambling connotations.

In any case choosing between CFDs and spreads bets is really a personal thing; some traders prefer CFDs due to Direct Market Access, others rave about the merits of spread betting as it is tax free (I'm one of them!), and on the indices you don't get stuffed on the spread, so as long as you're comfortable with the way that the providers 'mark to market' the contract value at the end of the period, I think it makes sense.

Q. Which are most cost-effective - daily rolling bets or equity CFDs?

A: It depends on the time-frame - trades of less than 3 weeks cost about the same whether using equity CFDs or daily rolling bets. Longer trades will usually work out to be slightly cheaper using spread bets based on futures prices.

Some companies do take a bit more when rolling the spread over BUT the financing for CFDs and spread bets, if we are talking about UK shares, is the same. If you do £10 per point on VOD at 150 that's a £1500 position - 1,000 CFDs at 150 is the same - £1500 position. The amount subject to margin would be the same in both cases.

Two ridiculous methods to trade: 1) the busy way and 2) the lazy way -:
1) actively look for (what wise guys refer to as) arbitrage opportunities, sit in front of the screen, stare at it for hours to look for things like divergence, and act and react, which can sometimes be very hair-raising, eg. the computer breaks down at a critical moment.
2) place your order and go away, something easier termed as cut-loss-ride-those-profits, which has less certainty of profits, but saves on operating expenses.

Q. Given all the tax advantages of spread betting, could you explain why institutions/hedge funds don't choose spread betting over cfds...I understand neither tool actually gives physical ownership of the underlying.

A: Spread Betting is only tax free if trading is not your main source of income. As (one would hope!) trading is a hedge/institutional fund's main activity it does not qualify as tax free. For this reason corporate accounts cannot claim spread betting revenue as tax free.

Also, for this reason it is inadvisable when opening a spread betting account to call yourself a trader or day trader as the IR may, if they requested the record from your spread betting firm, say that any income was taxable as you have actually designated yourself as a professional.

Also, since companies will pay corporation tax on profits from either a CFD or a spreadbetting account, so if they were to choose between the two, they will most certainly go for CFDs. The costs are also slightly cheaper when comparing the commission paid when trading CFDs (e.g. the commission on a UK shares would be 0.15%) compared with a 0.8% spread on a quarterly future.

Lastly, the spread betting industry at present is directed primarily at retail investors, as they do not offer the credit lines and other complex derivative products that Hedge Funds require. CFDs are very close to equity swaps, which historically hedge funds trade. This has tended to be the reason for institutions remaining with CFDs.

A hedge fund seeking to use derivatives is likely to go to a bank, because the bank can offer the hedge funds more complex derivative products apart from CFDs, which the hedge funds find useful for their trading strategies.

For some is better to say 'I'm Currency Trader' than 'I'm a Forex Gambler', so trading, speculating, investing, etc Investment banks and hedge funds won't try a gambling logo, 'We're gambling with your savings to get a good profit' ;).

Q. Do most professional day traders use spread betting in their day-to-day work or actual share transactions?

A: Depends what their goals are. From what I understand, swing and position trading is favoured over scalping, because of the filling speed and spread. For a trader with a reasonable amount of assets which he manages himself it makes sense to use spreadbetting as the preferred route as there is no CGT.

 ...Continues here - Spread Betting versus Direct Market Access Trading

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