There is a fundamental difference between spread betting and ordinary betting, and this can best be shown by using horse or dog racing as an example.
When you decide to bet on a horse or a dog before a race takes place, you select the animal that you think will win (or which might finish in the first three past the winning post). Then you shop round for the bookmaker who is offering the best odds against the animal of your choice. Incidentally, it is amazing how punters very rarely challenge a bookmaker on a race course to improve his offer, and if you do so, how very often it is possible to get better odds, particularly at point-to-point races.
When you have placed your bet, there is nothing that you can do about it until the race is run. You cannot cancel it during the race, or two minutes after you have placed it. You cannot claim any of the profit during the course of the race if your selection is leading the field at that time. If your selection (backed to win) fails to be first past the post, you have lost you entire stake. (The same applies if you had backed the animal for a place and it fails to make the grade). You have bet that at a certain time in the future (the end of the race) your selection will have achieved a certain position vis-à-vis the other runners, and you have to wait until the event has taken place, and the time has passed however long it takes, before you know whether you have made a profit or a loss. From the moment that you make the contract with the bookmaker you have lost control of that money. If the animal does win, then you know exactly how much money you will win, irrespective of what happens to the price after you have struck your bet with the bookmaker.
Financial spread betting differs from conventional betting in that there is no 'winning post', although there is a period of time involved. You select a share, index or commodity whose price you think will go either up or down over a period in the future and you approach a financial spread betting bookmaker to ask him for a 'price'. He will quote you a figure that he believes your selection will have achieved at the end of a specific time, and you decide whether you think he is right or wrong. If you think he is wrong, you place a bet with him that is based on a stake per unit (per penny in a share price or per point in an index) in the direction that you think the figure will be i.e. higher or lower than his quote. It is not important whether your selection achieves exactly any specific price on a specific date in the future, merely that the unit price exceeds or falls below the price quoted by the bookmaker at the time you made a contract, and whether it does or not, you can close the bet at any time whether you are making a profit or loss, before the specified period has elapsed, at which time the bet will be closed out whether you are in profit or loss.
Spread betting, therefore, is far more flexible than conventional betting, and you are in control of your financial affairs at all times. You can take a profit whenever one occurs, if you want so to do, or you can cut a loss at any time if you believe that your original prognosis was wrong.
The amount of money that you can make from financial spread betting can be considerable without the need to pay up money for a stake at fixed odds. The result of this is that the 'gearing' that can be working for you can produce spectacular wins of large amounts of money for no initial outlay. Remember that also that large losses can occur if you do not impose guaranteed stop-loss limits when you place the bet initially. Stop-loss limits can be altered, up or down, during the period that the bet is open, which can allow you to lock in some profit, or reduce further any potential loss.
When you want to place a spread bet on a share or index or commodity, you are quoted two prices - one at which you can buy (the offer price), and one at which you can sell (the bid price). The difference between these two numbers is called 'the spread'.
If you think that the price will go up, you place a 'buy' bet. If you think that the price will fall, you place a 'sell' bet. You are betting on the movement of the price, and you start by deciding the amount of your stake you will risk per penny movement of the price.
When you telephone a financial bookmaker to ask the price of a share in order to place a spread bet, he will quote you two prices - one at which you can buy (offer price) and one at which you can sell (bid price). They will always quote bid first and offer second. The difference between these two is called the spread. It is most important that you realise that whilst you may see a price on a screen for any given share, that is the 'cash' price in the market at which you can deal at that moment. The price that the bookmaker will quote you for the same share is the 'futures' price which will probably be quite a lot different from the cash price. You will be betting on the futures price, and you must choose whether it is the 'near' future, or the 'far' future that you want to use. The year is divided into four quarter days, 31 March, 30 June, 30 September, and 31 December. The near future date is the one closest to the current date; the far future date is the next one after that.
Whilst the futures prices bear some relationship to the current cash prices of most ordinary shares, there is often a delay before they may react to current news. They are reflecting what the market thinks the price of the share will be on that date in the future. You are betting whether, in your opinion, they are right or wrong, and which way (up or down) and by how much.
Don't forget that you 'open' a bet by buying at the offer price, or selling at the bid price. You 'close' the bet by dealing at the opposite price description e.g. if you open with the offer price, you close with the bid price, and vice versa.
For example, you think that the price of HCBC will rise. The current price is 935p to sell (bid), and 943p to buy (offered). These are prices quoted to you by the bookmaker and are based on the far future. You are betting that the price will rise so you place a 'buy' bet of £10 per penny @ 943p. This is called 'buying to open'.
The price rises to 962p to sell, 970p to buy. You decide to close the bet at that level, and you instruct the bookmaker to 'close the bet @ 962p.
Bought to open HSBC Ordinary shares @ 943p x £10 per 1p 943p.
Sold HSBC Ordinary shares @ 962p x £10 (to close the previous opening bet) 96 2p.
Profit 19p x £10 per 1p = £190 + 19p.
If the share price had moved against you (i.e. it dropped instead of rising), you would lose money at the same rate. For example, you placed a 'buy' bet to open at the offered price of 943p. The share price fell to 902p bid, 910p offered. You closed the bet at the bid price (to close a 'buy' bet you have to sell at the bid price) @ 902p.
Bought to open BP Ordinary shares @ 943p x £10 per 1p 943p.
Sold to close BP Ordinary shares @ 902p (to close the opening bet) 90 2p.
Loss 41p x £10 per 1p = £410 - 41p.
Suppose that you thought the price of BP would fall. The current price is the same as in the example above, i.e. 935p to sell (bid), and 943p to buy (offered). You are betting that the price will fall so you place a 'sell' bet of £10 per penny @ 935p to open. The share price fell to 902p bid, 910p offered. You closed the bet at the offered price (to close a 'sell' bet you have to buy at the offer price) @ 910p.
Sold to open BP Ordinary shares @ 935p x £10 per 1p 935p.
Bought to close BP Ordinary shares @ 622p (to close the opening bet) 910 p.
Profit 25p x £10 per 1p = £250 + 25p.
If the share price had moved against you (i.e. it went up instead of down), you would lose money at the same rate. For example, you placed a 'sell' bet to open at the bid price of 935p. The share price rose to 962p bid, 970p offered. You closed the bet at the offer price (to close a 'sell' bet you have to buy at the offer price) @ 970p.
Sold to open BP Ordinary shares @ 935p x £10 per 1p 935p.
Bought to close BP Ordinary shares @ 970p (to close the opening bet) 970 p.
-35p.
Loss £10 per 1p x 35p = £350.
By placing a financial stake through a bet, you are leveraging or 'gearing up' the relatively small amount of capital employed compared with purchasing the shares outright at the start. If you had wanted to buy the shares (invest capital) instead of betting on the price movement, you would have had to lock up capital and you would have incurred stockbroker's commission as well as government stamp duty.
Instead you have contracted to pay a certain sum of money (larger or smaller depending upon the amount of your stake) if your judgement turns out to be wrong and you lose your bet. If you win, you receive cash paid into your account immediately. You have not had to invest any capital into shares or stocks or any other instrument.
Even if you are convinced that a share that is listed on a recognized stock exchange is likely to fall, under current regulations it is almost impossible to make money by selling them unless you have previously bought them. This is called 'going short' of a share, and the practice is frowned upon by some. You can bet that the price will fall with total impunity, and you can indeed make money by so doing.
You can vary the amount of your stake every time you place a bet to open, but you must close the bet with a stake of the same amount. The amount that you stake will depend on your calculation of how much you are prepared to lose before you place a bet. It is good practice to 'write off' the whole amount of the potential loss when you place the bet. The way to establish this amount is by imposing guaranteed stop-loss limits every time you open a bet.
You might decide to bet on an index, such as the FTSE 100, or the Dow Jones. You can bet on the daily cash price of either of these indices, which means that your bet dies when that market shuts at the end of the trading session, unless you have closed the bet before that time, or, you can bet on the futures price for anything between three and six months ahead.
You can either bet on a futures based index, in exactly the same way and over the same periods as a share (as explained above), or you can place a daily bet. This type of bet dies at the close of business in the market to which it refers. The daily FTSE 100 will open at 0830 hours in London and close at 1630 hours. The daily Dow Jones opens and closes with Wall Street.
The amount by which an index moves in a day is generally not great, although there are rare occasions when falls of 60 to 80 points have been known in one single day, usually after a catastrophe or some extraordinary bad news such as a major bank failure, or substantial and very expensive disaster. Since the bookmakers will quote spreads of around eight points on indices, you need to see a minimum movement in the 'price' of eight points before you break even. It is better for the newcomer to bet on futures based indices where you have a better chance of making a profit.
You can spread bet on options as well, but it must be emphasized that the risk factor in this instrument for betting is very great. The 'gearing' attached to options is considerable, and this is increased substantially by superimposing a financial spread bet onto what is already a highly geared price. You really do need to understand how options work, quite apart from the influence that movement by the underlying cash price of the share or index, even though that movement may be in your favour. As the 'life span' of an option approaches its end, the price will weaken correspondingly.
When you consider placing a financial spread bet on an option, you will be given various strike prices to choose from, and these will be close to, or further away from the current cash price of the underlying instrument. These will be described as being 'in the money', or 'out of the money', depending upon the proximity of the cash price to the strike price.
Let us use an example such as BP. Assume it is November, and you are interested in betting on the March option. The current mid-cash-price of the share on the stock market is 638.5p.
The March PUT option strike price of 550p is quoted as 7p (bid), at 9.5p.(offered).
The March CALL option strike price of 700p is quoted as 11.5p (bid), at 14p (offered).
This means that if you think that the price of BP ordinary shares will collapse between now and the option expiry date in March, and you want to 'open' a financial spread bet by 'buying' a put at a strike price of 550p, you would execute the following transaction.
• Buy to open BP March PUT option at strike price of 550p @ 9.5p at, say, £100 per 1p (or whatever is the appropriate unit quoted).
If the BP Ordinary share price fell at any time between now and the option expiry date next March to, say, 600p, the price of the option would change to, say, 11.5p at 14.5p.
If you decided to take a profit at that time, you would 'close' the bet by 'selling to close' at the prevailing bid price of 11.5p.
• Sell to close BP March PUT option at strike price of 550p @ 11.5p at £100 per 1p.
In this example you would have shown the following result.
Bought BP March PUT option to open at strike price of 550p 9.5.
Sold BP March PUT option to close at strike price of 550p 11.5.
Profit 2.0.
2.0p x £100 per 1p = £200.
You can see that if the underlying share price falls, the bid and offer prices of a PUT option at a strike price that is lower than the cash price will rise.
Thus, as you would expect, if the underlying share price falls, the bid and offer prices of a CALL option at a higher strike price will fall.
Using the same example, assuming that you had thought that the underlying share price of BP was going to rise, you might have bought a March CALL option at a strike price of 700p. which was quoted as 11.5p (bid), 14p (offered) .
You would have executed the following transaction.
• Buy to open BP March CALL option at strike price of 700p @ 14p at £100 per 1p.
However, the BP share price fell to 600p. You decide to close the bet and cut your loss before it falls any further. To do this, you have to 'sell the CALL to close'. The costs of a 700p CALL option have now fallen to 9.5p (bid) at 12p (offered).
• Sell to close BP March CALL option at strike price of 700p @ 9.5p at £100 per 1p.
The result would have been as follows.
Bought BP March CALL option at strike price of 700p 14.
Sold BP CALL option at strike price of 700p 9.5.
Loss 4.5p.
4.5p x £100 per 1p = £450.
There is another choice open to you. If the underlying share price continues to move in your favour, you can hold the bet open until the option terminates, and provided that the cash price in the market of the underlying share is below the PUT option strike price (assuming you bought a PUT option to open), or above your CALL strike price (assuming you bought a CALL option to open), then you may make a profit. However you have to take your costs of opening the bet (option costs) into consideration to calculate your profit or loss.
In the examples shown above, the following calculations would apply to arrive at the cash share price required before you break even.
At a strike price of 550p, with a PUT option cost of 9.5p already paid, the cash price would have to fall to 540.5p. Any further fall would put you into profit by the amount of the difference.
At a strike price of 700p, with a CALL option cost of 14p already paid, the cash price would have to rise to 714p. Any further rise would put you into profit by the amount of the difference.
Stop loss limits can be imposed when the financial spread bet is opened, and it is recommended that they should always by used to control your exposure to potential high risk.
This study aimed at beginners or those with no knowledge at all and also at intermediate investors who wish to improve their returns. The author of this study is veteran stockbroker and spreadbetting guru Charles Vintcent. Charles is the author of the best-seller, How to Make Money from Financial Spread Betting.
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