Strategies: Clever Uses of a Spread Bet (Part 2)

I wish I had his I.Q.!

# Bet on sector mean reversion

In 1999, IT Hardware was the best performer out of 32 FTSE sectors. A year later, it was 30th, and a year after that it came bottom. That pattern is fairly typical for sectors. Forestry came top in 1994, and bottom in 1995. Personal Care & Household Goods came top in 2002, and 26th last year. Only twice in the past 18 years has a sector managed a top 10 performance for three years in a row (Software starting in 1996, and Personal Care in 2000). You can use spread bets to speculate that a sector which has done brilliantly one year, will fail to match the market thereafter.

# Weight your sectors evenly

Tracker funds are great for quick and easy exposure to stock markets, but they do have their drawbacks. If sectors tend to overshoot (see No 36, betting on sector mean reversion, above), then trackers will invest most in a sector when its value is inflated – and just as it is set for a fall. Using sector spread bets, though, you can easily weight a portfolio evenly, and rebalance it at the beginning of each year.

 

# Turn your technical analysis hunches into trades

The speed, variety and cheapness of spread bets make them ideal for implementing technical analysis. You have no taxes to pay, can get in and out of positions in seconds, and set stop-losses in case you’re wrong.

# Play ‘Dogs of the Dow’

It sounds unlikely, but it still works. On 1 October each year, you invest $10,000 in the 10 shares from the S&P 500 that have done the worst over the previous three years. You hold them for a year, before selling out and reinvesting the cash in your ‘Dogs of the Dow’ portfolio. So far, the anomaly has kept working. Had you done this every year since 1996, your $10,000 would now be worth more than $1,000,000. The problem is buying out bombed US shares. With a spread betting account, it would be child’s play – although there is no knowing when this anomaly will break down.

# Use the Nasdaq to spread the risks of holding individual tech stocks

Whether you believe that UK technology stocks are caught up in another bubble, or that the good times are here to stay, it will be the Nasdaq that leads the tech sector up and down. So then, why invest in individual UK stocks – with all the company-specific risk they add – when you can take out a spread bet on the Nasdaq instead?.

# Bet on a resurgence of volatility

When stock markets have traded within a narrow range for months, you may think that a major move is more likely (be warned, though, that volatility can collapse for years on end). If you’re confident of a big swing, but not sure in which direction it will be, you can use a ‘straddle’ to make money out returning volatility. Manoj Ladwa, of ETX Capital, offers an example using Vodafone, which currently trades around 140p. A straddle would give you the option to sell Vodafone at 140p in six months’ time, if you wanted, but also to buy Vodafone for 140p at the same point in time. There are significant costs involved in setting up the straddle, but provided Vodafone moves a long way from its current 140p level, you can choose which option to exercise and make a profit. ETX Capital lets its customers set up a straddle using spread bets, which it then converts into options, adding on the costs plus a commission.

# Take hourly positions on the FTSE

IG Index offer spread bets on where the FTSE 100 will be at the turn of each hour.

# Make money out of collapsing volatility

Some financial derivatives, such as futures, options and contracts-for-difference (CFDs), will nosedive if market volatility collapses. Any underlying shares you own will trade sideways – and make you nothing. With spread betting, you can bet that an index will trade within a range. If you are right, you can make money out of the status quo.

# Find your own correlations

If stock markets are evenly roughly efficient, it is only because people are always on the look out for anomalies or aberrations. Join in the hunt, but don’t look where everyone else is looking. If you can find two assets that tend to rise or fall together, you can then watch for periods when they drift apart, and use a long and short spread position to bet that the gap will narrow.

# Place stop-losses

Some online stockbrokers let you place automatic stop-losses on share deals. But with other brokers, you have to watch out for falling share prices yourself. It’s a lot easier with spread betting. Your typical online spread betting website will let you put a stop-loss on at practically any level – very useful if you have a highly geared position that could cost you a packet if it goes the wrong way.

# Place guaranteed stop-losses

Some spread betters will also offer guaranteed stop-losses (internet trades only). Imagine that you have placed a stop-loss to close your position if Tesco’s shares fall below 200p. Some calamity befalls the company, and its shares trade down in chunks from 252p to 240p, 217p and 201p. Your stop-loss has yet to kick in. Now imagine that the shares gap down again to 195p. No shares changed hands at 200p, so your stop-loss would kick in at the first trade, at or beneath your stop-loss.

Your position would be closed at 195p. However, with a guaranteed stop-loss (also known as a controlled risk bet), you pay a wider spread to get in and out of the position, but your stop-loss is guaranteed.

# Set limit orders

Limit orders are a piece of cake with a spread betting account. You want to get into J Sainsbury, but its shares are bobbling about all over the place. You decide not to put up with this short-term volatility, and instruct your spread better to open a position only if (or when) Sainsbury’s shares are 5 per cent lower than their current price.

# Combine limit orders and stop-losses in ‘If Done’ orders

Set up a pair of trades that will get you into a share once it falls (or rises) to a given point, and will then automatically close your position at a second specified point.

# Set up ‘One Cancels the Other’ (O-C-Os) orders

These orders, often referred to as O-C-Os, allow you to plan out quite complex scenarios. The simplest way to think of them is like this. With an O-C-O on ITV, for example, you can tell the spread better to buy ITV if it falls to 125p, and sell it should it rise to 160p – but don’t do both. You could reverse the instruction and short the share if it falls beneath what you believe to be a resistance level. As a corollary, you buy ITV if it pushes past its resistance level.

# Set up a two-factor sell stop

Some trading platforms allow more complex orders. This example comes from iDealing. Suppose you own a position in 10,000 Telewest shares. You also know that Cable & Wireless (C&W) has called a press conference tomorrow that could cast a pall over the whole sector. You decide that if C&W drops by more than 5p by midday tomorrow, you will close out your Telewest position at the market price.

# Take country positions

The correlations between major stock markets around the world have risen over the past 20 years. But if you think this trend is ripe for reversal, you can go long or short of particular countries using spread bets on the national stock market indices. As well as UK and US markets, Deal4free offers spread bets on the major indices of Japan, France, Germany, Italy, Netherlands, Finland, Spain, Sweden, Switzerland and Australia.

# Strip a sector of its duds

Over the past decade, shares within the same sector have become increasingly highly correlated. A consequence of this is that, in the short term, the duds will rise and fall with the darlings. But sooner or later, you can expect quality (or the lack of it) to assert itself. If you think that the sector as a whole will rise, you can go long of the sector and short of a particular stock to capture the relative outperformance.

# Back a stock relative to its sector

This is simply the reverse of stripping a sector of its duds. You may think, for example, that the IT sector is perilously overvalued, but still have faith in a particular company, say, iSoft. As long as iSoft does better than its peers, your spread bets will make you money. There are obvious permutations to this strategy (see below).

# Strip a market of a sector

You’re bullish about prospects for equities, but you can’t believe a certain sector can keep pace with the overall market. You go long of the market, and short of the sector.

# Back a sector relative to the market

You’re bearish about the market, but bullish about a particular sector. A pair of spread bets will make you money, if you’re right.

# Strip the market of a stock

You’re confident about the market outlook overall, but there is one particular stock you’re sure will falter. As long as the stock does worse than the market, then whatever happens, you’ll be quids in.

# Back a stock relative to the market

You’re neutral to negative about the market as a whole, but believe you can identify one stock at least that will do well. Even if both the market and your stock fall, you make a profit – provided the market does worse.

# Take out spread bets on the daily closing prices of indices

If you want to stay in the market for as long as possible, without holding a position open overnight (and paying finance charges), IG Index offers bets on where the FTSE will be by 4.30 pm.

# Carry out pairs trades

Strange but true: Shell Transport & Trading has a higher correlation with BP than it does with Royal Dutch Petroleum, even though Shell and Royal Dutch are parts of the same company. Over the past decade, Shell’s shares have edged ahead of BP’s over 10 times, always to fall back. It’s a classic pairs trade: you wait for Shell’s share price to approach BP, then bet that the gap will increase by going long of Shell and short of BP.

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