Spread Betting vs CFDs
In the world of finance, a number of instruments allow investors to trade in products they need not actually own. The popularity of such products has increased in the last decade following the advent of the global financial crisis during which the markets saw a free fall and investors lost trillions of dollars across asset classes. Further, the rise of the internet and innovations in financial technology increased the ease of trading among investors.
Two products that have become extremely popular and are fundamental to the equity, forex, and index markets are Contracts for Difference (CFDs) and spread betting. Both spread betting and CFDs are leveraged products. Given seeming similarities between both the products, investors often ask which of the two products is better. At first glance, there seems hardly any difference between spread betting and CFDs. Spread betting is also a margined product and as in case of CFDs, at a small fraction of the total value of the underlying asset, an investor gets exposure to the asset. However, a closer look reveals a number of differences between these two asset classes.
To know these differences, investors should first understand how CFD trading works vis-à-vis spread-betting. In CFD trading, the investor enters into a contract with a financial institution or a broker and at the end of the contract, the investor receives an amount that constitutes the difference between the closing and opening price of an asset. CFDs are a derivative financial product because it is derived from another financial instrument. CFDs allow investors to speculate on the future value of the underlying asset. In CFD trading, an investor can choose to take a long position in expectation of an increase in the underlying asset or a short position where the investor believes the price of the underlying asset will decrease in value. In both the scenarios, the investor expects to profit from the difference on the closing value and opening value of the asset.
However, a spread bet is not exactly a derivative product because the spread betting company quotes the difference between the buy price and the sell price independent of the underlying asset. The movement in value change of the underlying asset is measured on basis points and the investor has the option to purchase short and long positions. Although the quoted spread betting price could vary from company to company theoretically, it does not happen in reality because computer based algorithms could help exploit the difference in prices and support arbitrage trading.
In the case of spread betting, investors speculate on upward or downward movement per point of the spread bet – unlike in CFDs where the investor speculates on the change in value of the underlying asset. Spread bets have a fixed date of expiration whereas CFD contracts do not have such an expiration date. Further, spread betting happens over-the-counter through a broker whereas investors can complete CFD trades directly within the market if they choose to. This direct market access makes CFD trading simple and more transparent. A stop-loss order can be placed in both CFDs and spread bets prior to initiation of the contract.
Both the strategies can be profitable and the risks are apparent too. Both CFDs and spread betting are about making money in a rising or falling market, and in both cases you do not have to own the underlying asset. Given their fundamental similarities, new investors may miss some nuanced differences. Further, CFDs can be bought on real assets only whereas spread betting extends to wider markets such as sporting events. The charging for both these instruments is different. CFDs attract a commission fee whereas spread betting is free of commission fees. Instead, the charge is loaded into the difference between the buy and sell price. Profits earned from spread betting are not subject to capital gains tax. However, losses made on CFD trading are tax deductible and the investor can do the trades through direct market access.
Risk is an integral part of investing and investors can make losses in CFD trading as well as spread betting. Both spread betting and CFDs are particularly effective during periods of high volatility because they are quick to trade and allow investors to respond to market movements nimbly. Ultimately, the choice between spread betting or CFDs would depend on the preference of the investor and the type of market in which he would want to trade.
