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Thursday, 25th April 2024 |
| A guide to financial spread betting |
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| Financial spread betting is a way of trading on a financial market or product such as a share or a commodity without having to physically own it. The Guide on this page provides an overview of the main questions investors ask about how they can go about engaging in this form of tax efficient trading and hedging. Spread betting is best seen as a risk management tool; it enables the user to both take on and offload risk, and thereby hedge, or offset, underlying risk that might exist within other long or short positions. Because of the potential leverage possible through spread betting, it can magnify risk positions, and thus care and due consideration must always be foremost in engaging in any trading activity. |
Spread betting allows you, an investor, to bet on whether the price of a financial instrument will go up or will go down in value. For every point an instrument moves in your favour, you win multiples of your stake and for every point it moves against you lose multiples of your stake.
Your profit or loss is the difference between the price at which you buy and the price at which you sell. As you do not physically own the product, but bet solely on price movements, you can profit from falling markets as well as rising markets.
If you think that a certain financial market will rise in value, then you ‘buy’ the product, known as ‘going long’, and you will aim to sell it at a higher price. If you think that a financial market will fall in value, then you ‘sell’ it first, known as ‘going short’, and aim to buy it back at a cheaper price.
‘Buying’ in a rising financial market
If you buy in a financial market that you believe will rise in value, and in due course your prediction is correct, you can then sell for a profit. Financial spread betting is not without its risks though, and if you are incorrect and the value falls, you make a loss.
‘Selling’ in a falling financial market
If you sell in a financial market that you believe will fall in value, and in due course your prediction is correct, you can then buy back at a lower price, for a profit. If you are incorrect and the value rises, you make a loss.
Margin trading
Spread betting is a leveraged product which means that you are only required to deposit a fraction of the overall value of the trade. Typically margins with CMC Markets vary between 1 and 10 per cent. Margin enables you to magnify your return on investment. However, losses will also be magnified so margin trading is not necessarily for everyone.
What is the ‘spread’ in spread betting?
Prices of financial instruments are quoted in pairs known as the bid and the offer. The bid or ‘sell’ price is quoted first and the offer or ‘buy’ price is quoted second. The spread is the difference between bid and the offer. If you were viewing the price of Ryanair for example it would look like this:
• Ryanair 2.80 / 2.813
The price to the left is the Sell price and the price to the right is the Buy price.
If our Ryanair spread is priced at 2.80 / 2.813, that means you could either:
• Buy at 2.813 if you think Ryanair will rise in value.
• Sell at 2.80 if you think Ryanair will fall in value.
Benefits of spread betting
Financial spread betting is a way of trading on a financial instrument such as a share or a commodity without having to physically own it. This means that financial spread betting has a large number of benefits over traditional ways of trading such as buying and selling shares through a stockbroker.
Tax free trading in the Republic of Ireland: For Irish residents, the profits you make from financial spread betting should be free from capital gains tax and income tax. However, this is open to interpretation and you should consult an independent tax adviser as the tax position may be affected by your individual tax status.
Commission free trading: With financial spread betting there are no commissions to pay, no matter how often you trade.
No stamp duty: Unlike traditional share trading, financial spread betting incurs no stamp duty when trading
on shares.
Profit when markets fall as well as rise: Traders can profit from bull and bear markets. Because you are trading on the price movement of a financial instrument without physically owning it, it is as easy to initially sell the instrument as it is to buy it. This is known as ‘going short’ and allows you the opportunity to profit from a fall in the instrument’s price by selling high and buying back cheaper.
Margin trading: Financial spread betting is a leveraged product which means that you only have to put up a percentage of your total exposure to the market. This is an efficient use of your money because you only need to allocate a small proportion of the value of your position to secure a trade.
In effect, you are able to magnify the returns on your investment. Losses too will be magnified so margin trading is not necessarily for everyone. Typically margins with CMC Markets vary between 1 per cent and 10 per cent.
Access to global markets: Spread betting allows you to trade on a whole host of global instruments all from one account. Spread bet on Shares, Indices, Commodities, Sectors, Treasuries and FX 24 hours a day.
1000s of financial markets: CMC Markets offer a comprehensive spread betting service on thousands of instruments including Shares, Indices, Sectors, Commodities, Treasuries
and Forex.
Shares: Spread Bet on 50 Irish stocks, all of the UK 100, UK 250 and over 100 small cap shares. Plus thousands of leading US, European, Asian and international shares.
Stock indices: One can obtain a wide variety of spread bets on the world’s stock indices, including: UK 100, US 30, US SPX500, German 30, France 40 and other European indices, Aussie 200, Japan 225 and other Asian indices.
Sectors: Prices in UK and US stockmarket sectors, including Mobile Telecoms, Insurance, General Finance, Banks and Household Goods.
Commodities: A wide selection of commodity spread bets including Oil, Coffee and Pork Bellies.
Treasuries: Spread bet on the main interest rate contracts, including Short Sterling, Gilt, Eurodollar and T-Bond.
Source: CMC Markets
Example trade - going long
ABC Corp is trading at 159.75 / 161.25. You think that the new product they have just released will sell well and the share price will rise so you decide
to buy.
You place a buy bet (also known as going long) at 161.25. Remember that share prices are quoted in pairs – the bid and the offer. The bid or ‘sell price’ is quoted first and the offer or ‘buy price’ is quoted second.
If you are new to spread betting you trade the minimum amount of €1 per point, which is the equivalent of 100 shares in the real market.
ABC Corp is margined at 5 per cent - this means that you only require 5 per cent of the total position’s value and this will be allocated from your account as initial margin. In this example it will be €8.06 (5% x (€1 x 161.25)). Remember, if the share price moves against you it is possible to lose more than your initial €8.06 margin.
Outcome A: Winning trade
Your prediction is correct and 2 days later the share price rises by 20 points to 179.75 / 181.25. You decide to close your trade and sell at 179.75.
You have made 18.5 points (179.75 - 161.25) x €1 = €18.50 revenue. You held the position for 2 days which means you have incurred 2 nights financing charge.
The financing charge for the first night is €0.04. This is calculated by taking €161.25 (value of your exposure to the market at the end of each day) x EONIA + 3% (which in this instance +8%) / 365 (number of days in the year = €0.04. The second night the share price is slightly higher and the financing charge is €0.05.
Therefore you deduct both night’s financing charges from the total revenue and realise a total profit of (€18.50 - €0.09) = €18.41.
Outcome B: Losing trade
Your prediction is incorrect as the share price falls by 20 points to 139.75 / 141.25. You decide to close your trade and sell at 139.75.
You have lost 21.5 points (161.25 - 139.75) x €1 = minus €21.50 revenue.
You held the position for 2 days which means you have incurred 2 nights financing charge.
The financing charge for the first night is €0.04. This is calculated by taking €161.25 (value of your exposure to the market at the end of each day) x EONIA +3% (which in this instance +8%) / 365 (number of days in the year = €0.04. The second night the share price is slightly lower and the financing charge is €0.02.
Therefore you add both night’s financing charges from the total revenue and realise a total loss of €21.56 (€21.50 + €0.06).
This example uses a stake of €1 per point but you can trade in any multiples of €1, for example €3 or €10. If you had traded with a stake of €5 in this example you would have made a profit of €92.41 or a loss of €102.50. Trading with larger sizes increases your risk so make sure you understand the risks involved.
Example trade - going short
Qwerty Corp is trading at 222.00 / 224.50. You think that Qwerty Corp is over-valued and the share price may fall so you decide to bet on it going down.
You place a down bet (also known as going short) of €1 per point at 222.00. NB share prices are quoted in pairs – the bid and the offer. The bid or ‘sell price’ is quoted first and the offer or ‘buy price’ is quoted second.
If you are new to spread betting you trade the minimum amount of €1 per point, which is the equivalent of 100 shares in the real market.
Qwerty Corp is margined at 3% - this means that you only require 3 per cent of the total position’s value to open a trade and this will be allocated from your account as initial margin. In this example, the total margin will be ((222 x €1) x 3%) = €6.66. Remember, if the share price moves against you it is possible to lose more than your initial €6.66 margin requirement.
Outcome A: Winning trade
Your prediction is correct as the next day Qwerty Corp issue a profits warning and the share price falls by 50 points to 172.00 / 174.50. You decide to close your trade and buy back at 174.50.
You have made 47.5 points (222.00 - 174.50) x €1 = €47.50 revenue.
As you held the position overnight, you are owed a financing charge. CMC Markets will pay EONIA - 3% on all short positions (nothing if less than 0). In this case, if the closing price that evening was 190 you would receive €0.01 (190 x €1 x EONIA (assume 5%) - 3% / 365).
Therefore you add the financing charges to the total revenue and realise a profit of €47.51.
Outcome B: Losing trade
Your prediction is incorrect as a rumour of a takeover bid means the share price increases by 18 points to 240.00 / 242.50.
You decide to close your position at a loss by buying back at 242.50. There is a difference of 20.5 points (222.00 - 242.50) x €1 which is a loss of €22.50 to you.
As you held the position overnight you incur a financing charge. The financing charge is €0.06. This is calculated by taking €222 (value of your exposure to the market) x EONIA + 3% (in this case + 8%) / 365 (number of days in the year) = €0.06.
Therefore you add financing charges to the total revenue and realise a loss of €22.56.
This example uses a stake of €1 per point but you can trade in any multiples of €1, for example €3 or €10. If you had traded with a stake of €5 in this example you would have made a profit of €237.5 or a loss of €112.50 (plus or minus a financing). Trading with larger sizes increases your risk so make sure you understand the risks involved. |
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| Article appeared in the June 2008 issue.
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