Spread betting is a speculation, that is making a bet on the price movement of a security. A betting company quotes two prices, the bid and the ask/offer and the investors will bet whether the price of security will be lower than the bid or higher than the ask/offer. The investor doesn’t own the securities, they just speculate about the price movement.
Spread betting explication
Spread bettings allow investors to speculate over price movements with different financial instruments like stocks, forex, commodities and securities. Spread betting is an amplified product, which means investors only need a small percentage of bond from the value of the position. If the value of position is 50 000 dollars and the margin is 10%, they only need 5000 dollars of bond. That increases both the profit and loss which means the investors may lose more than their initial investment was.
An example of spread betting
Let’s pretend a betting company imposes a bid of 200 dollars and an ask/offer of 203 dollars for an ABC share. The investor believes that ABC will drop down under 200 dollars. For every point that the share drops under 200 dollars, the investor bets 20 dollars and makes the trade. If ABC drops to 190 dollars, the investor will make a profit of 200 dollars (20 x 10). If the price goes up to 215 dollars, the investor will lose 300 dollars (20 x 15). The spread betting company demands a 20% marginal, which means the investor will have to have a cover of 800 dollars on their account (20% x 4000 dollar position value). The position value comes from multiplying the size of the bet and and the price of the share (20 x 200 = 4000 dollars).
Benefits of spread betting
- Long/short: Investors have a chance to bet both on prices that are going up or down. If they are trading physical stocks, they have to borrow a stock they are planning to sell short and that can take time and be expensive. Spread betting makes short selling as easy as buying.
- No commissions: Spread betting companies earn money through the currency gap they offer. There is no seperate commission, which makes it easier for investors.
- Taxes: In some jurisdictions spread betting is seen as gambling and the profits may not be taxable. Investors that bet should ask advice from an accountant.
Limitations of spread betting
- Marginal calls: Investors that don’t understand financial leverage, may take positions too big on their accounts and that may bring margin calls. An investor should not risk any more than 2% of their deposit on one transaction and they should always be aware of the position value.
- A wide spread: On a period of volatility spread betting companies may widen their spread. That may bring stop-losses and increase the transaction costs. In order for investors to avoid a widening spread, they should avoid making orders right before companies disclose their revenues and annual reports.
Forex spread betting
Forex spread betting is a category in spread bettings where you bet on the price movement in currency pairs. A spread betting company usually quotes two prices, the bid and the ask. Traders will bet whether the currency pairs price is lower than the bid or higher than the ask. The more bounded the price difference, the more attractive the pair is since entering and exiting costs less.
Forex spread betting examples
The benefit of forex spread betting is that it gives investors and traders an opportunity for leverage. The investor lends money from a company to bet on a currency, needing only the capital that is required to finance the bet, not the amount of the whole bet.
For example a brokerage quotes for the EUR/USD pair 1.0015 for the bid and 1.0010 for the ask. If the trader believes that euro will increase compared to the dollar, they can bet 0.5 euros for every pip that goes over 1.0015. If after some time though EUR/USD reaches 1.0025, the trader will get 5 euros. If the price of euro was 1.0005, they would lose 5 dollars.