SpreadBetting - How it works - Part 2

Spreadbetting is most easily explained through an example - the concept is the same whatever the market. Imagine that in early August you believed the FTSE 100 index's value of around 6230 was too high and that share prices would fall over the following month or so. Accordingly, to spreadbet City Index for a quote - it gave you a FTSE 100 price for the third week of September of 6165-6175. Based on that spread, you had two choices. You could have bet on the Footsie falling below this level, by selling the index. Or you could have bet it would be higher than this in September, by buying the index. Either way, you bet by staking a sum, say £10, per point. As you expected the Footsie to fall, you took the former option. Now imagine that on 17 September, the FTSE 100 actually closes at 6020, 145 points below the City Index spread. On this basis, your profit would be £1,450 - 145 times your £10 stake. In fact, you do not have to wait until 17 September to book your profits. Gamblers can close their bets as soon as they become profitable. If the index had stood at 6050, say, on 1 September, you could have closed out your bet by reversing it - buying points from CityIndex.

However, the downside of spreadbetting is that the potential for large gains is equalled by that for large losses. Imagine that you had bought, rather than sold, points from City Index in the example above. Your loss would have been a nasty £1,550 - £10 times the 155 points the Footsie finished below your opening spread. It is important to note that in spreadbetting gains and losses are geared. The more right you get a bet, the more you win. But the more wrong you are, the greater your losses.

Not surprisingly, spreadbetting companies are wary about bad debts. They will only extend credit to investors who can meet any losses. Expect calls for cash from your bookmaker if your bets move into the red. On the other hand, all the firms say that, unlike conventional bookmakers, they do not lose on winning bets, as they lay off risks in the underlying markets. Spreadbetting firms, therefore, do not mind successful gamblers.

A spread bet price always has two parts. The first is the BID or the price you can sell at. The second is the ASK or the price you can buy at.
The Ryanair price is €6.00 – €6.06.
This means you will gain €5 for every cent the price moves up and lose €5 for every cent the price moves down.
You think the Ryanair price will rise and buy at €6.06 for €5 per cent
If the price rises to €7.06 – €7.12
If the price falls to €5.06 – €5.12
You sell at €7.06
You sell at €5.06
Your profit is
(7.06 – 6.06) x 100 x €5 = €500
Your loss is
(6.06 – 5.06) x 100 x €5 = €500
Betting on the FTSE 100 index allows you to speculate on a stock market without needing to choose individual shares.
The FTSE 100 index bet is priced at
6500 – 6502.
This means you gain €4 for every point the price moves down and lose €4 for every point the price moves up.
You think the index will fall, so you sell at 6500 for €4 per point
If the price falls to 6398 – 6400
If the price rises to 6598 – 6600
You buy at 6400
You buy at 6600
Your profit is
(6500 – 6400) x €4 = €400
Your loss is
(6600 – 6500) x €4 = €400
A great way to trade oil is to spread bet on the price of Brent Crude
Brent Crude is priced at
$90.00 – $90.04.
The Brent Crude price is in US Dollars but with spread betting this is irrelevant. Your gains and losses are paid for in the same currency as your account.
You think the price of oil will fall, so you
sell at $90.00 for €1 per cent
If the price falls to $84.96 – $85.00
If the price rises to $94.96 – $95.00
You buy at $85.00
You buy at $95.00
Your profit is
(90.00 – 85.00) x 100 x €1 = €500
Your loss is
(95.00 – 90.00) x 100 x €1 = €500
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Further Examples of how SpreadBetting Works

Example one

  • The FTSE 100 market is quoted as follows: 5600-5602
  • It is possible to buy at 5602 (the offer price) or sell at 5600 (the bid price)
  • The investor believes the price will go higher than 5602 and bets 2 per point
  • Their expectation is correct and they choose to sell at 5642
  • They can then claim 80 (40 * £2 per point)

Example two

  • The FTSE 100 market is quoted as follows: 5600-5602
  • It is possible to buy at 5602 (the offer price) or sell at 5600 (the bid price)
  • The investor thinks the price will go lower than 5602 and bets £1 per point
  • Their expectation is wrong and you decide to sell at 5622
  • They would lose money as 5622-5602= -20 * £1 per point = loss of £20

Remember: Indexes have been known, on occasion, to move by hundreds of points at a time. For example, in May 2010 the DOW fell over 950 points in what become known as the Dow Jones 'flash crash' and in June 2010, the DAX rose by more than 300 points in several days.

The range of trades available through spread betting has also mushroomed over the last two years. Most providers for example, now offer spread betting on at least 40 global stock market indices and a multitude of currencies and commodities. Investors can also bet on the individual share prices of the largest 350 companies in the UK. Most providers also offer downside protection, allowing investors to specify how much they are prepared to lose on any bet. Some providers even also offer guaranteed stops which will automatically close out your bets 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.

Nevertheless, spreadbetting is not simply for short-term gamblers. In particular, it 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.

Tips

  • As with most things involving a risk, the savvy people will ensure they are fully prepared, so that if the worst does occur they are not badly hurt. This makes it important to research the products you wish to trade and take full consideration of the risks associated with this sort of investment. Although a vast experience is not required to spread bet, being as well informed as possible is always a good idea.
  • Try using technical analysis to help with your investment choice - this is offered by virtually all spread betting firms. Making use of charts and technical tools is a wise idea and it is best to discover who offers the services required. If such indicators predicted the markets to fall, you can instruct your broker to 'sell' the FTSE. The same is true if signals suggest a summit point of profit is likely to be reached.
  • Some strategies are more popular than others and you might like to find out more about market trends, scalping, break-outs and reversals before parting with your cash.