Rolling Cash Settlements and Hedging your Positions

Welcome to the next section of your spread betting course. And in today's message you'll see how rolling cash can benefit you. Importantly, you'll also learn how you can use rolling cash to hedge your positions. Let's get started.

Daily rolling, put simply, is betting on the outcome at the close of trading. You will be able to find out when trading closes by looking at your spread betting firm's market information sheet. When day trading and you think things will continue in your favour the next day you can roll the trade overnight. You will be charged a small sum for doing this though - so if you do want to hold a position for a long period of time you should have a look at futures trading. The big advantage of betting on daily markets is a smaller spread which means you can trade the market at less cost to maximise your profits.

How rolling cash settlement can reduce costs

Until recently, the majority of quotes available in spread betting were forward date contracts and it was difficult to compare futures quotes with a quote from your traditional stockbroker due to the ambiguity surrounding how a spread bet quote was formulated. This was because for quarterly contracts, the spread betting provider has to build in the additional costs involved in running that position for a longer period; therefore the spread will be slightly larger.

But things have changed, thanks to 'rolling cash' spread betting.

The difference rolling cash has made

The advantages of the traditional cash market have been married with the benefits of spread betting, and the product of this union is called rolling cash spread betting. Now there is a real alternative to traditional share dealing. Rolling cash spread betting (or 'daily cash', depending on the firm) lets you roll your spread bet over to the next day. It has opened up the market by providing price transparency. Now you can compare rolling cash spread bet quotes with quotes from your stockbroker and then make a more informed trading decision as to which product is most appropriate. This returns the balance of power to you, presenting the opportunity to instantly relate the rolling cash quote to a tangible physical cash quote.

The ability to roll positions overnight can be important, because you can capture share price advances and declines that may occur when the cash market is closed. Also, due to the leveraged nature of the spread bet product, you can run the same size positions as you would in physical share trading without having to deposit the whole cash consideration.

It creates transparency

One word sums up the advantage of rolling cash spread betting: transparency. Rolling cash bets allow you to participate in the market with a product that is more in line with physical share or CFD trading, but with the added bonus of being tax-free. The bets allow you the opportunity to build up positions over a period of time and control your exposure to any market by offering controlled risk bets, limit orders and 'market on close' orders.

An example of a rolling cash bet: on Monday morning ARM Holdings (rolling cash bet) is trading 369 - 370. You have a short-term bullish view on this share. You decide to buy £5 a point of ARM (rolling cash) at 370. Over the next couple of days the share moves slightly but you continue to hold the position looking for further gains. During Thursday's trading session the Nasdaq market makes significant gains, pushing up UK tech shares on Friday's open. ARM is now trading at 388 - 388.5 and it is now that you decide to close out the bet by selling £5 a point at 388. The bet has realised a profit of £90 ((388-370) x £5).

The only deduction is the four days' overnight financing charge. The financing charge for keeping the position open overnight for four days would have been £1 (based on SONIA - Sterling Overnight Index Average - being 3.5%). In this scenario, SONIA would be just £1, so a £5 bet on a share that moved 18p in your favour would make you a tax-free profit of £89. Not bad for a few days' work!

How to calculate the cost of financing

You are charged financing daily on the value of your position, according to the following equation.

Total number of shares = £ per point x 100
- Total market consideration = number of shares x share price on market close

If you have a long position, you pay SONIA +1.5%
If you have a short position, you receive SONIA -2.5%

A rolling cash bet is, depending upon your investment strategy, potentially the most useful instrument you can use to gain equity market exposure, because it can be used to speculate, hedge or enhance yield. As a bonus, it's exempt from CGT.

Ways to use rolling cash to your benefit

When going short

Shorting is made possible by the fact that rolling cash bets are not physical shares but they mirror the market movement, which means that it is as simple to sell a share or index as it is to buy it. Rolling cash bets, therefore, allow investors to benefit from falling markets in the same way as they would traditionally benefit from a rising market. Another benefit of speculation using rolling cash bets is the lack of ancillary charges.

The flexibility presented by shorting can be exploited to develop more sophisticated trading strategies.

How rolling cash helps when you're hedging

Let's say you are long 100,000 physical shares of Vodafone. You may have decided that you do not wish to sell the cash position, but would like to lock in the price of your current position. Therefore, you decide to short sell 100% of the value of those shares via a rolling cash bet. The result is you have a complete or partial market neutral position. If the cash market goes down 5p, you make 5p via the rolling cash bet position. This strategy can be employed to defer a CGT tax liability.

However, you need to work out whether the costs on such a transaction make this move worthwhile. Look at the overnight financing charge or the cost of rolling a spread bet overnight and the width of the spread. The longer your trading timeframe, the more expensive rolling cash becomes on a relative basis.

The rollover in action

A firm's daily share quote is 526.7 - 529.8.
You make a down bet of £20 at 526.7 and decide to roll the bet over.
Your bet is closed at 4:30pm at the market close of 530 and then re-opened at 530.1, to reflect interest.

Your loss today has been £66 (3.3 points x £20 a point).

The futures market may not be an ideal place to hedge your portfolio because the contract sizes are restricted to a minimum £10 per point. Dealing in this denomination may not give you the flexibility to accurately hedge your portfolio. If the value of the Vodafone position is £72,000, that equals 1.7 FTSE futures contracts, given a FTSE 100 market rate of 4200 (£72,000/4200 /£10 per point = 1.7 futures contract). But 1.7 is not a tradeable amount on any futures exchange.

However, with the wide range of indices available, you have the flexibility to deal in denominations of £1 per point or lower with some spread bet companies. Therefore, if you are wanting to hedge your Vodafone position, you can buy 17 rolling cash bet FTSE 100 at £1 per point, more accurately matching the total contract value of your Vodafone shares.

Use it to enhance your yield

Any rolling cash bet position requires a percentage of the trade to be used as initial margin and may require additional funds to maintain the position. However, if a notional £100,000 position requires £20,000 initial margin, you can use the remainder of the funds to purchase government bonds or other short-term cash instruments. Indeed, some institutions will accept these instruments as collateral. In effect, rolling cash bets traded on a margin basis enable you to allocate funds more efficiently and allow for the potential maximisation of collateral.

Performance and pairs trading strategies

Performance and pairs trades are becoming more popular as investors become more confident with rolling cash bets. Here's what you need to know about them.

Performance trades commonly compare the performance of an individual share to the broader market or to the relevant market sector. If you believe Vodafone will outperform the blue-chip market you may buy Vodafone rolling cash bets and simultaneously sell the equivalent value of the FTSE 100 - for example, buying 50,000 Vodafone at 144p (value £72,000) while selling £17 per point of the FTSE 100 at 4200 (value £71,400).

It is possible to make money no matter which way the market moves, as long as Vodafone outperforms the market index.

Pairs trading with individual shares

A pairs trade usually compares the performance of one share against another within the same industry and are therefore intrinsically linked. If you believe Shell will outperform BP, you buy Shell and sell BP in equivalent amounts, looking to exploit a diverging correlation between the two shares. This type of trade relies on specific company data and is popular when earnings results are expected.

Equity performance

As you do with shares, you benefit from normal market movements. Your open positions are valued every night at the close of business rates. Profits or losses will be credited or debited to your margin account each day. Corporate actions are applied to your account if they occur. Most importantly, you can buy and/or short sell any spread bet offered on any underlying share offered.

Next time

Up to now, you've learnt the ins-and-outs of spread betting: setting up an account, using a stop loss, making use of indices, and why rolling cash settlements are a good idea. But there's one important question - one that is regularly asked - that we've not answered this far. And that's why should you spread bet in the first place? There are numerous other products available to traders, like using contracts for difference (CFDs), or just investing in shares. In the next course, we'll take a look at the difference between spread betting and CFDs, and the advantages of each. See you then.

>> Next Page - Comparing Spread Betting to CFDs and Shares Trading

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