An interesting question of how dividends are covered in spread betting
This was the question I received a few weeks ago from Derrick. Since I thought this might be of interest to our readers I’m publishing the answer here:
I already hold FWY in my Sipp, and have no cash in the Sipp left to increase my FWY stake. I cannot invest through my ISA, and as a 18% tax payer have used or already allocated this and next years CGT and income tax allowances.
So I am interested in a spread bet as an alternative to a straight purchase which would attract 18% CGT and income tax on dividends. Effectively an alternative form of purchase (with available funds to cover) rather than an opportunity to leverage my position. I am new to this and feeling my way – the attraction here, which also applies to AMN, is solid downside cover with decent upside potential. I have today registered with IG index.
My question is this. I understand the basics, but not how the dividends are covered. Let’s say I buy FWY at £1. A special dividend is paid of 50p – do I get this? Let’s now say that following the dividend the price falls to 60p – where does this leave my bet – down 40p or up 10p?
I assume that there are others here who hold such positions and would be very grateful for a layman’s guide to the issue. And if you think I am wrong in my analysis of this as a newbie spreadbetting opportunity please say so!
First, a quick explanation of ex-dividend – If a share price is marked ex-dividend, it means you’ve just missed the dividend and will have to wait another six months before you get one from the particular company. Often shares prices fall once a stock goes ex-dividend, but not always. It’s best to know when ex-dividend day is, before you decide whether or not to sell. Keep a record of when your dividends are paid. So Aphid’s theory… pay attention class… is that there is often a build up in buying of a share, just prior to it going ex-dividend, because then as a shareholder you obviously get the dividend paid with that share. The day after the dividend is issued, the share no longer has an immediate known dividend value, you have to wait another 6 months or year for next dividend, consequently it will tend to drop by around the value of the dividend paid. This drop is usually marked down over-night for the morning opening.
I have an IG Index account I don’t hold FWY as a spreadbet but have had other shares that have pay dividends while I hold e.g. LLOY.
I’m pretty sure what happens is a “corporate action” is applied to the bet. So basically if you opened FWY at say £5/point at 100p and FWY paid a dividend of 50p on the day the bet goes ex-dividend your effectively get the 50 * £5 = £250 added to your account but your bet “winnings” will probably decrease by 50 * £5 = £250 as the share goes ex-dividend because all things being equal the share price will drop by the dividend. You don’t therefore loose out but you don’t make anymore either.
One of the slight-downsides to spreadbets is because you only pay margin you end up financing the bet which is often 2% over Sonia so about 7%. Suppose therefore you hold a position of £10,000 over a year you’ll end up paying £700 in financing costs. These are not really that transparent since they are built into the bet but they are there. You can of course offset these to some extent by putting the £10,000 if you have it in a deposit account and get say 5%. You’ll get normal dividends too so this helps offset financing costs.
The upside is the saving of 18% on tax which is more likely than not will offset the extra funding costs you pay. That said don’t forget if everything goes pair shaped and your holding goes down in value you can’t offset this loss against other gains in your portfolio. Some say the reason the government don’t clamp down on tax free spread betting is because if they taxed gains they would also have to give tax relief on losses. Given that a lot of people get a bit carried away with margin and more often than not loose money with spread bets this is probably the reason they are tax free.
Another upside is that because you don’t pay commission on a per trade basis you can average down into a position in relatively small chunks.
I think if used with discretion they are a very fine way to invest. I normally keep the same value as my spread bets in a high yield deposit account so that I am effectively not margined and the interest earned goes quite a lot way towards paying financing costs.
I strongly recommend, however, that you study the terms and conditions your spreadbetting company provides. These spell out what happens in such situations (and many others, including how interest is applied) it is important that you are aware of and understand them. Dividend practices vary across companies, and we explore this topic in greater depth here.
This is a vital part of DO YOUR OWN RESEARCH if you use spreadbetting or any other financial derivative.
Other Questions
If I am long does the price suddenly drop when the share goes ex-dividend?
‘On the quarterly markets the dividend is in the price already so there should be little to no effect on dividend payment date. On rolling bets we will pay 80% of the dividend to a client with a long position and the share will probably open the full dividend amount lower on the next opening. In rolling markets we merely quote around the current market price so if the price falls or not on ex-div date is entirely up to the market itself. In a totally efficient marketplace if the dividend were 10p then the price should drop by this on the morning after ex div but in many cases it does not. Dividends will be credited/debited (for those who are short) the night before the ex-div date.’ – Spread Betting Insider
Note on dividends it is always advisable to check on ex dividend dates not just in spread betting but in ‘real’ equity trading as well. The market can be very odd. Sometimes a dividend gets paid and the market falls far less than the div amount and on other occasions you get the opposite effect.
If I am long a UK rolling daily bet why am I not entitled to 90% of the dividends (as with CFDs)?
‘We do not pay dividends…we make a debit/credit to reflect dividend price action. You must remember that this is a bet, you do not actually own any shares. You may get 90% of the dividend via a CFD but you will then have to pay tax on this whereas with the bet you get 80% flat. If I were you I would ask why you don’t get 100% on the CFD as you then have to pay tax on it.’ – Spread Betting Insider
Can you tell me why I only get 80% of a dividend if long and debited 100% if short when the payout from a brokerage firm is 90%?
‘The reason that we do this is because of the tax situation. If a client owns a share that is going to have a big dividend (on which he will have to pay 25 to 40% tax) it would be much better for him to sell the shares before ex-div date and take a spread bet out as he would then get 100% of the dividend in a price reduction and then on the day after the ex-div trade back into the shares. We reduce this to 80%. When you take into account spread/dealing costs…etc the 20% reduction in the dividend removes this temptation (!). This might (we believe) make our company compliant in attempts at tax avoidance which would at the very least (if it became very prevalent) bring the eye of the taxman very firmly in our direction. In the real world you have somewhere between 25 and 37 per cent tax on dividends. We believe that the 20% charge plus attendant dealing costs make it less likely that we are seen to be aiding tax avoidance.’ – Spread Betting Insider
