Lessons from the Pros – Is Spread Betting for Me?

by Tony – Kent – UK

Beware Leverage Creep…

Part of my decision to use spread betting is partly to avoid CGT exposures, but also I’ll freely admit the ability to use some degree of leverage is also part of the reason for me.

I tend to buy the longest period quarterly bets available as this meets my expected/potential holding time. So therefore at the moment I’ll be buying positions with December expiry rather than June or September – these will generally be the most cost effective if you are likely to hold that long.

I set my spread bets to automatically ‘roll over’ on expiry (unless I’ve taken out the position for a specific short term purpose). When you ‘roll over’ a position you generally pay a only portion of the spread relative to closing the old bet and opening a new one as ‘normal’ transactions. This does though mean that for positions you hold long enough to need to roll over the actual financing cost is dependent on the spread for the specific stock. So it’s well worth looking twice at the spread when opening a position you expect you may want to hold for a longer period.

Always keep in mind – the higher leverage you use, the greater the chace for large losses. Most providers give way too much leverage = rope to hang yourself with. I rarely use more than 5:1 leverage but it’s easy enough to get 100:1. This means you can wipe out your entire account in a few minutes, if you are unlucky/foolish enough.

It’s also worth noting that bets will generally roll over to the ‘near’ quarter as matter of course. So my December positions will roll over to March-08 positions meaning that I will have to roll over again in three months (rather than 9 if I rolled them over to the ‘far’ quarter). On a couple of occasions I’ve asked my spread betting company to roll positions over to the ‘far’ rather than the ‘near’ quarter and they have done so – I’m fairly sure this was more cost effective but I do recall not being totally convinced I was getting quite such good terms as for a standard rollover – Something I probably should look into further!!

Probably the biggest learning point for me though has been to look very carefully at the actual cost of the spread and to avoid the smaller less liquid stocks where the bid offer spread on top of the normal market spread can be quite outrageous and significantly dent your resources. So try to reserve your spread betting for the more liquid positions where the spread betting margin should not be so damaging and hold any illiquid stocks as ‘real’ shares. This is a balance I have not yet got right and writing this article is a useful reminder to me to reshuffle my resources a little to enable me to strike the right balance.

The other thing I feel compelled to warn about is to beware of “leverage creep”.

Most investors will at some time or another come across the irritating phenomenon of finding a great value share when fully invested and with nothing that one wants to sell at that time. Spread betting provides the easy answer by way of increasing leverage ‘temporarily’ beyond your intended limits. With the utter certainty that at least one of the wonder stocks you own is going to see its true value any day now at which point you can redress the balance it becomes a bit of a ‘no-brainer’ (or it feels that way).

Been there – done that and even though ‘any day now’ tends to often be more distant than you would imagine – it’s always come out for the good so far and to be honest I’ve never extended the limits too far but I’m very mindful of the fact that these copper bottomed buying opportunities are highly likely to appear in number towards the top of a market slide. I would say no-one can truly be comfortable with their management of leverage until they have lived through a sustained market crash (as a serious investor I haven’t).

One answer to this of course is to maintain a cast iron will and never EVER go beyond your self imposed leverage limits (or at least don’t buy beyond it) – this requires one to stoically shrug one’s shoulders at the missed opportunities. Another answer (and I suppose what I informally do) is to set a normal conditions leverage limit and a slightly higher ‘exceptional circumstances’ limit and have both sufficiently low to allow for the vagaries of the market.

I’m sure there are more lessons than that, but those are the major ones that come to mind.

So has spreadbetting worked for me?

I think so – but given the way I use spread bets it’s not easy to be totally categorical. Certainly the positions I have spread bet have made me less profit than they would have had I used normal shares (that’s guaranteed) and because my worst ever investment outcome happened to be mostly held in spread bets I haven’t yet made enough CGT savings to redress the balance – but that is really a statistical wrinkle that is ironing itself out over time rather than any problem with spread betting per se.

On the other hand the leverage and flexibility afforded to me by spread bets have enabled me to diversify where I otherwise would not have been able and therefore to enter profitable positions that would otherwise be denied me. Given that I also look set to redress the CGT balance this tax year I’m totally satisfied that spread betting has worked for me – but avoiding the traps has not been effortless at all.

So I would suggest giving it a go but maintaining a very close monitor on how it works for you both in terms of the costs (financing and extra spread) vs the saved CGT and in terms of your own ability to avoid the lure of leverage.

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