Spread Betting can be bewildering to anyone coming across it for the first time, with terms such a 'pips', 'margin', 'spread' and so on being bandied around. But the concept is actually very simple, and needn't be difficult to understand. Essentially, spread betting allows you to bet on the movement in the price of financial instruments. This is no different to any other forms of investment. The crucial difference between spread betting and most other forms of investment, however, is that, firstly, it is more flexible (you can bet on the price going down (called going short) just as easily as you can bet on the price going up (called going long), and secondly, it is tax free – there is no stamp duty and no capital gains tax to pay. It really is worth emphasizing this last point - spread betting is entirely tax free.
Rather than buying an amount of stock, say, you bet directly on the movement in the price of an instrument. So, for instance, you make a bet on Barclays Plc equity that for every penny the share price increases you receive £1. Of course, in this instance, for every penny the share price fell from your opening position you would need to pay £1. Betting that the price of an instrument will rise is often referred to as 'buying' an instrument, or going 'long'. Betting that the price of an instrument will fall is called 'selling' an instrument, or going 'short'.
The type of financial instruments you can bet on are not restricted to equities or equity indices (such as the FTSE 100) either. Most spread betting firms allow you to bet on foreign exchange (known as 'forex'), commodities (including oil, gold etc), bonds, as well as more esoteric financial instruments such as house price indices. The exact range of instruments available differs by spread betting firm.
Sports spread betting, incidentally, is exactly the exactly the same – so, for example, rather than betting on the final result of a game (win or lose), you can bet on the number of goals scored, or yellow cards shown etc.
The best way to illustrate the benefits of spread betting is by using a worked example. Assume you want to invest £10,000 in a FTSE 100 tracker fund. If you invest when the FTSE 100 is at 5,000 points, and the index subsequently rises by 10% to 5,500 points, you have made a 10%, or a £1,000, return on your investment. Now if, instead of buying a tracker fund, you had opened a spread betting account, what you could have done is – when the FTSE 100 was at 5,000 points – taken out a spread bet of £2 per point that the index will rise. When the index subsequently rose by 500 points you would also have made a £1,000 return (500 points × £2). So the spread bet trade was exactly the equivalent of the purchase of the tracker fund. The advantages of using spread betting however, are that there is no trade commission to pay (retail brokers that allow you buy and sell funds typically charge you £10-£20 per trade – that’s both to buy and then again to sell it), and no taxes (stamp duty or capital gains). Furthermore, you wouldn't have needed to invest as much money to make the trade if you had spread bet – taking out a £2 bet on the FTSE 100 would typically require you to have £600 - £2,000 (depending on which spread betting operator you use) deposited in your account (this is called either the 'deposit' or 'margin' requirement). Buying the tracker fund would have required you to invest £10,000. And if you believe the index is going to fall you could place a spread bet just as easily going the other way, while there’s no way (easy) way to do the same simply by buying and selling a FTSE 100 index fund.
This ability to place large bets while only putting up a relatively small amount of money is why spread betting is often referred to as a 'leveraged' or 'geared' type of investment – with a given amount of money, you can make or lose much larger sums compared with other types of investment. And herein lies one of spread betting's key advantages, but also its danger. Always bear in mind that – if you're not careful – you could overstretch yourself and potentially lose more than your initial deposit. To keep track of your exposure at any given time I often find it useful to compare my spread betting exposure to what I would have needed to invest if I was buying the investment outright – so, for example, buying into the FTSE 100 at 5,750 for £15 a point is equivalent to investing £86,250 (5,750 × £15) in a tracker fund! The deposit and margin requirements are different for different financial instruments, and also differ between spread betting firms.
It's worth mentioning in relation to the example given above that, in reality, if the index had risen by 500 points you would have made slightly less than £1,000. This is because of what is called 'spread'. Spread is simply the difference between what you can buy and sell an instrument for at any given time. It is how the dealers make their money. So to go back to the example above, if the FTSE 100 was at 5,000 points, you would be offered two prices; a buy and sell price (often referred to as 'bid' and 'offer'). In this case the buy and sell prices would typically be 5,001 and 4,999 respectively. If you wanted to buy the index (i.e. make a bet that the price is going to rise) you would have to buy in at 5,001. Likewise, once the FTSE 100 rises to 5,500, the buy and sell prices would be 5,501 and 5,499. To close the position you would need to sell at 5,499. Thus your actual return from a 500 rise in the FTSE 100, at £2 per point, is likely to be around £980 ((5,499 - 5,001) × £2).
Finally, one other thing to note is that for any given instrument you will often see a number of different options, all with different dates attached to them – these are called different 'contracts'. So for instance if you search for ‘Brent Crude’ you might find 'Brent Crude Daily', 'Brent Crude December' and 'Brent Crude January' (different spread betting platforms all have slightly different terminology). These simply indicate when each contract is due to expire. Daily contracts will expire (i.e. settle) at the end of the day. Longer contracts will typically expire half-way through the month indicated. The differing prices for the different contracts simply reflect how the market expects the price to move over time. If the price goes up for longer contracts then the market expects the price to rise over this period. This is sometimes referred to as 'contango'. The opposite of this is 'backwardation'. Spreads will also typically be wider on longer contracts.