Spread Betting Is Worth The Risk For Clued-Up Traders

THE persistent refusal of Chancellor Gordon Brown to make any commitment to reform Stamp Duty Reserve Tax on share transactions - at 0.5 per cent the highest in Europe - has played a large part in the remarkable growth in popularity of Contracts for Difference (CFDs) and spread betting.

Since, unlike conventional instruments, CFDs (read more about them on http://www.contracts-for-difference.com) and spread bets do not confer ownership of the underlying asset - traders buy or sell the price movement in the underlying equity without ever taking delivery of it - neither is subject to stamp duty. And because spread betting falls within the gaming laws, it is also exempt from Capital Gains Tax.

The other key appeal of spread betting is that, as a margin product, it enables traders to gear up their investments. And because, as a margin product, traders could potentially lose a multiple of their initial stake, spread betting is recommended for use only by professionals, day traders and experienced investors.

But while there are risks attached to spread betting, there are various tools available - such as guaranteed stop losses - that can help manage that risk by, for example, inputting to the system parameters to alert traders to specified price movements.

Another reason for the recent growth in the popularity of spread betting can be attributed to the fact that, in addition to speculating on the underlying equity, investors can trade on the various indices. Indeed, spread betting enables traders to profit from both up and down movements on a wide variety of financial markets, whether indices, individual shares or commodities, such as gold or crude oil.

Unlike fixed odds betting, under spread betting traders don't risk a certain amount per bet, and there is no fixed profit or loss.

That's because the profit and loss on a financial spread bet is always open as the trader is betting a stake - usually pounds per point - on the direction of the market.

For example, a trader might expect the FTSE 100 index to rise and so decide to buy it at £2 a point using a spread bet. If the trader bought the FTSE 100 index at 4950, risking £2 a point, and then sold it when it rallied 50 points to 5000, his profit would be £100. But if the index moved lower and the trader subsequently sold his bet at 4925 to take a loss, then he would lose £50.

This is the difference between fixed odds betting and spread betting - a trader's ultimate profit and loss with spread betting is never known until he liquidates the bet.

Using spread bets a trader can also bet on a downward market by selling short. If he was bearish towards the FTSE 100, expecting lower prices in the future, then he could sell the index short at say the market price of 4950, and then cover this bet or buy it back at 4900. If his stake was £2 a point then his profit would be a tax-free £100.

But if his view is incorrect and the FTSE 100 rises, and so he decides to take a loss by buying back his down-bet or short trade at 5000, losing 50 points multiplied by his £2 stake represents a £100 loss.

The most significant cost in spread betting is the spread - the difference between the bid and the offer price - and this is the main reason why hedge funds use CFDs and not spread bets. The wider the spread, the more a speculator will pay to trade.

Fortunately, though, spreads are getting tighter due to increased competition as investors are beginning to realise the advantages of financial spread betting.

Spread betting appeals to the same kind of market as CFDs, namely experienced traders, active in the market who understand the risks associated with margins and gearing. Much of spread betting can be short-term trades, volume-based, high volume day traders coming in and out of positions.

Experienced traders all spread bet for the simple reason that if they can make £10,000 from spread betting, then they can keep £10,000 spread betting, rather than handing over a significant proportion of it to the taxman.