How Spread Bets Compare to Contracts for Difference

We're nearly half-way through the spread betting course. And up to know you should have all the basics of spread betting covered. But why should you spread bet in the first place? How does spread betting compare to contracts for difference? Well, read on to find out more.

Often, when talking about spread betting, the topic of contracts for difference (CFDs) comes up. Many spread betting firms also offer CFDs, so it is worth comparing them.

House prices going up or down? Win either way!

You think your flat in Islington looks expensive and want to hedge part of your investment against a price decline.

The March 2002 Islington flat future is 214.9 - 219.8.
You sell £200 per point at 214.9.

Two months later, you go to close the bet.
You are quoted 206.3 - 211.2.
You buy £200 a point at 206.3.

You make £1,720 (8.6 x £200), and don't have to pay any CGT.

You can bet on housing prices in England and Wales, Greater London, Wales, Southeast London and Northern England, as well as on specific property types in London Boroughs. Spreads are currently based on the Residential Property Price Report, as published quarterly by HM Land Registry, or on the Halifax House Price Survey.

Like a spread bet, a CFD is a trading instrument where you can go long or short of a share or market. There are many similarities between CFDs and spread bets. Importantly, they are both margined instruments, offering geared exposure to the underlying share or index. And, due to the nature of margined instruments, a short position is no more difficult to open than a long one. Because no ownership of the underlying share is conferred, neither instrument attracts stamp duty.

But there are differences as well. A significant difference is that CFDs have no set expiry date and the same position can be held open indefinitely.

Spreads are different

With CFDs, the costs of financing the position and commission are not wrapped into the spread, but are charged separately. Because of this, the CFD spread quote will always be very close to the underlying price, because the financing cost for the CFD is directly accounted for at the end of each day. In some ways, therefore, CFD prices can be regarded as being more transparent than those for spread betting.

CFDs mimic shares

Essentially a CFD mimics every aspect of owning the underlying share or market without actually doing so.

With CFDs, if you hold a long position you receive the benefit of any dividends being paid on the underlying share, with spread bets you don't. In theory this sounds like an advantage with CFDs, but in practice future cash flows such as dividends should be accounted for in the forward price, and therefore accounted for in the prevailing spread bet price.

Unfortunately, that also means you are liable to paying CGT. This surely undermines the attractiveness of the product. However, there is some compensation in that CFD trade losses can be offset against capital gains, which is not the case with spread betting. If you're hedging, or arbitraging, this could have an impact on whether to use spread betting or CFDs on the likely losing leg of the position.

When trading CFDs, contracts are purchased in a similar fashion to purchasing shares. In other words, if you wanted exposure to 1,000 shares of Vodafone, you would buy 1,000 CFD contracts at, say, 130p per contract. By contrast, with a spread bet you would place a £10 per point bet on the price movement of Vodafone to hold the same position in the market (an overall exposure of £1,300.).

Spread bets are different from shares

The difference between spread betting and shares is that you do not have to just buy and wait. If your opinion is that a share or market is going down, you can place a down bet that will make you money if the underlying goes down.

There is also no waiting for a broker to pick up the telephone. Online spread betting has transformed the industry, narrowed spreads and allowed traders to trade in seconds. Twenty-four-hour and out-of-hours dealing are a feature of many spread betting companies. One of the most scandalous aspects of the bull market and, indeed, anytime the markets are fast, is how long it takes to get through to a stockbroker or get an execution price from some futures brokers.

How spread bets compare to CFDs and shares

Spread Betting CFD Trading Share Trading
Broker commissions No Yes Yes
Stamp duty No No Yes
Dividends (or dividend equivalent) No Yes Yes
Shareholder rights and perks No No Yes
Trade on margin easily Yes Yes No
Short easily Yes Yes No
Stop losses widely offered Yes Yes No
Fixed contract expiry date Yes No No
Trade many markets from the one sterling account Yes Yes No
Cash settlement Yes Yes No
Capital gains tax No Yes Yes

Spread betters hold the aces

Are you now convinced that spread betting holds many aces over CFDs and investing in shares? Indeed, spread betting certainly makes life a lot easier. But that doesn't mean that spread betting automatically means big gains for traders. In order to perfect spread betting, you need to have the right strategy and attitude...of which all will be revealed next time. Until then.

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