Are Spread Prices ever Skewed?

Q. Are spread prices ever skewed?

A: This is one of the main concerns with many spread bettors. Some believe that the firms will skew their prices in line with market trends - adding to the offer price when the customers are going long and lowering the bid when they are going short. This is particularly worrying if you are trying to exit in a hurry.

Theoretically, if you read the small print, most spread betting providers are entitled to change their spreads as they see fit. This is in effect what bookies do to hedge their books - they will shorten or lengthen the odds as the punters place their bets to discourage or encourage further 'action'. However with increasing competition and increased sophistication amongst the customers this is not quite as simple as it may sound - such a skew in spreads would open up arbitrage opportunities between the different providers which a sharp spread bettor could instantly take advantage of for a risk-free return. The solution for the spread trader is to have more than one spread betting account to retain flexibility. However, with the passing of the Markets in Financial Instruments Directive (MIFID) in November 2007 spread betting companies are now obliged to offer best execution.

Q. Do spread betting companies move the spread around to advantage themselves?

I would like to know if spread betting companies shift bets and spreads to balance (hedge) client positions? In other words will a spread position always follow the share or do they 'shift' the spread to encourage/discourage further 'action' [i.e. like a sportsbook hedges its positions] - and if so won't this open arbitrage opportunities with other spread betting companies?

Is this Myth or Reality?

If an underlying stock trades with a spread of, say, six points, you would have thought that if the share price was at, say 5000, the spread would be sell at 4997, buy at 5003. This is often not the case. The share price could be at 5000, but if the spread trading provider believes the market will move up, they might set the spread to be say sell at 5001, buy at 5007. As the market moves up to, say, 5008, you might have thought that you would have won. However, now if the bookies think the market will stall, or fall, they may move the spread to sell at 5004, buy at 5010. So, even though the market has moved in your favour if you bought it when it was at 5000, you would find yourself on the end of a 3 point loss. So you might decide to hang on, but then if the market falls and they move the spread to their advantage to below the price of the underlying security. Now, if the security falls back to 5000, but they have moved the, now falling, spread to sell at 4994 buy at 5000, you'll find that if you come out, you're looking at a loss of 13 points, when the market has not actually gone down from when you placed the bet. Admittedly this example is a bit of a worst case to illustrate what can happen.

A: The short answer is that this is a myth. Moving the spread would not only open up arbitrage opportunities between the different spread betting companies (which bookies generally hate), but also with the Markets in Financial Instruments Directive (MIFID) passed last November spread betting companies are now obliged to offer best execution. Lastly, remember that the companies are OBLIGED to trade the actual price of the security at the end of the life of the bet. I've even posed this question to the big gun asking for their comments and their replies are given below:

City Index -> 'Please be advised that our spreads always follow the market. If you have a rolling position this will continue until you decide to close it or until the underlying instrument stops trading. If you have a March, June or quarterly bet, the you trade will close on the expiry date at the official expiry price or when you decide to close it, whichever is first.'

IG Index -> 'I would like to assure you that we do not shift bets and spreads to balance our clients positions. To make our prices we simply wrap our spread around the market spread, and add on the premiums when dealing with futures contracts. However, you are always trading on our price rather than any price in the underlying market. When the bet expires the bet will settle as per terms of the specific market, i.e at the official closing price on the day of expiry.'

Capital Spreads -> 'In response to your question we do not shift bets and spreads to balance client positions. We place our spread around the price in the underlying market, which is derived from regulated exchanges.'

Q. My son read that some spread betting companies purposely adjust their prices near your stop loss so that it is breached.

A: I have checked this out and I am completely satisfied that spread betting providers do not fiddle the pricing to take out client stops. This is not a popular answer with people who have lost money, therefore I looked into it quite thoroughly. Logic calls for two reasons: for one thing yours is not the only position and they'd have to have really erratic (read: volatile) pricing to take out a significant number of stops. Secondly, the explanation for their mickey mouse prices is that the contracts I bet on, for example, reflect futures pricings rather than the market 'spot price.' I should have figured that out when I started. I'm a dick. Daily rolling prices are much closer to the market, you might notice.

Q. Obviously the betting company wants my money and would love the share to start to dropping...

My concerns are if I open a long position for example take BYG at £50 per point £5.50. That would give me an exposure of £27,500 or the equivalent of this amount of shares. When I place my bet does the company actually purchase the shares? Obviously the betting company wants my money and would love the share to start to dropping, so do they have the means to make this happen i.e. start to sell big chunks of BYG shares?

A: The spread betting firm makes money whichever way the share moves - by charging you a wider spread than they can get themselves - so there is no advantage to them in trying to push an entire market in one direction for the sake of screwing one punter. They don't need to. They profit every time regardless.

As for whether they actually trade the stock for real in the market in a quantity that matches your trade - they might or they might not. They will initially aggregate all bets - if there is a mix of up bets and down bets on a particular stock, those may mostly balance each other out, and it's only the remaining one-way bet they need to consider hedging. In which case the trade they place in the market may not tally with a particular one you just opened.

So they make their money on the direct market access and turn of the spread. That is just my understanding. In addition, I did once read an article that if they are dealing with a particular poor performing account they "hedge" buy even less so they make even more.

In some cases spread betting is appropriate, in others not. There are advantages and disadvantages. I find that with big liquid shares you tend to get pricing pretty similar to the underlying. With smaller illiquid names it is more prohibitive/erratic. I often hear people complain but it turns out it's because they have had a hard time trying to trade volatile small caps.

Q. I've been stopped out although the price never got anywhere near my entry price...?

A: Spread betting providers, whilst following the market, are not giving market prices. This means that their prices are only indicative, and it is quite possible for them to spike above or below the market at times.

Now in general, they'll be pretty good about trying to stick close to the market price (also because otherwise they would be hit by arbitrage traders), and if you question a spike they may well put you back in the trade if it was a way off, but this depends on the market you were trading and what their spread was in the first place (hence factoring spread in stops). Also, any stock or commodity with low volume is more likely to cause 'slippage' as there are less trades and so the price can vary in one single jump.

In such cases cross-check the price with a third party feed such as Bloomberg and if the price never came near your stop level, then query it with your spread betting provider, pointing that out. Otherwise, I'd suggest you keep track on similar trades, widen your stops a bit (or look for trades with tighter spreads) and try to profile stocks with higher volumes so that you're more likely to get close to the price you want - less spikes.

Whilst the market is quite complex at times, spread betting adds another level on top of that, which requires careful attention and there are 'quirks' to learn.

Q. Does investing via the spread betting route actually impact the underlying price of the share (or whatever is being spread bet)?

I mean, if you go long via a spreadbet will that increase the demand on the underlying share, and hence help increase the underlying price (and vice-versa for shorting)? For some reason I'd always assumed spread betting was like betting on the horses... in that the outcome of the race doesn't get influenced by who currently has bets...

A: It depends upon the total, net, exposure of the spread-betting company. They have internal thresholds, so if a spread-bet takes them over their exposure limit they will match/hedge the bet in the underlying market.

However, don't think that you are automatically connected to the shares, your counter-party as such is the spread betting provider. Just remember that all bookmakers/spread bet providers will try to limit their exposure and they will hedge/match the bets that they take and may take up a market position to limit their exposure to some of the bets that they cannot hedge/match.

Conversations go something like this:

Me : I'd like to buy Soco at £100 a point.
SB : That's 10,000 shares in Soco, let's see what we can do....
SB : Level 2 is showing 2,000 at Y... do you have a limit.
Me : Just see if you can do it for Y.
(sometimes a wait of a minute or two)
SB : We have 7,500 at Y, shall we just leave the order in for the rest?
Me : yep, fine.
etc...

In conclusion the underlying market can and does move when spreadbetters buy or sell.

Q. What happens if everybody on earth simply spread traded - wouldn't the markets not stop moving?

If everybody on earth simply spread traded would the markets not stop moving altogether if nobody actually bought the underlying asset?

A: Spread betting can only work as a concept if there is volatility in the market. Therefore if large numbers of people spread betting caused the markets to slow down, people would stop spread betting as there would no longer be an incentive to do so.

For large shares, there will always be a large number of people wanting to buy or sell at a particular price, meaning that one client's actions are unlikely to effect the underlying market price. Most spread betting providers have a policy of never owning more than a certain percentage (say 2%) of a stock. This ensures that the actions of their clients do not have a meaningful impact on the underlying market price.

Also, a provider may potentially offer a limited size in which to trade especially for illiquid stocks. 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).

...Continues here - Do spread betting firms hedge their customers' bets?

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