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Spread Betting

Updated on April 4, 2024
Article byWallstreetmojo Team
Edited byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

What is Spread Betting?

Spread betting refers to placing a bet on the price movement of a security. It is a trading strategy where traders do not earn from buying or selling an asset but by speculating the direction in which the market is expected to move. Investors can spread bets on currency pairs, forex, indices, commodities, shares, treasuries, and cryptocurrencies.

What Is Spread Betting

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A stock broker offers a bid price, and an ask price. In the spread betting process, investors have to predict whether the price would be lower than the bid price or higher than the ask price. If the same goes right, they win.

Key Takeaways

  • Spread betting is more or less betting on future movements in the market.
  • It is all about betting on the movement of security with respect to its price. Generally, a spread betting company quoted two prices (ask and bid price).
  • Spread betting enables traders to trade in various markets, including currency pairs, forex, indices, commodities, shares, treasuries, and cryptocurrencies.
  • The profits earned from spread betting shall not be charged for capital gains tax and stamp duties.

Spread Betting Explained

Spread betting is all about trading in market directions. Here, investors do not own an asset, but they predict its price movement. Based on their experience and the market trends, investors speculate if the price of the security will rise or fall in the future. It is different from taking a traditional trade where investors buy stocks, hold them, and sell when the prices are high.

Depending on their prediction, traders place a bet on the price movement for security. If the bet is accurate, they enjoy gains, while they lose if their speculation goes wrong and the market moves in the opposite direction.

As the investors/traders do not have the ownership of the asset, they can either choose to go short (sell bet) or go long (buy bet), considering the market’s direction. For example, if they expect the market to go up, they can click on buy, while if they think the market will go down, they can click on the sell option.

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Determinants

Three components help explain spread betting better – spread, bet size, and bet duration. First, traders have to pay a charge while dealing with the brokers. In a spread bet, this charge is covered by the difference between the ask priceAsk PriceThe ask price is the lowest price of the stock at which the prospective seller of the stock is willing to sell the security he holds. In most of the exchanges, the lowest selling prices are quoted for the purpose of the trading. Along with the price, ask quote might stipulate the amount of security which is available for selling at the given stated price.read more and bid priceBid PriceBid Price is the highest amount that a buyer quotes against the “ask price” (quoted by a seller) to buy particular security, stock, or any financial instrument. read more, referred to as the spread. This differential amount becomes the fee that traders pay to open a position. In short, the traders do not have to pay anything. Instead, it is the spread that covers the cost.

Spread Betting Components

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The bet size is the next important factor that guides the deal. Choosing a bet size helps traders allocate the portion of their funds to each trade on a per point basis. In addition, it indicates the amount investors are likely to lose or gain for each point of the price movement for an asset in the market. For example, if traders go for a $2 per point spread betting for an Amazon stock going up, for every movement upward, they earn $2. On the other hand, if there is a downward movement in the market, they would lose $2 for every point-wise drop in the prices.

The bet duration marks the period before a position expires. Every bet comes with a fixed tenure, which can be for a day or even months in a row.

Margin

In spread betting, traders have to start with depositing a small initial amount to open a position or initiate trade. This amount is known as the margin. It can be of two types – deposit margin and maintenance margin. While the deposit margin is concerned with the primary funding required to initiate a position, the maintenance margin is the additional fund that would be required to maintain the open position.

The brokers use the maintenance amount to cover up the losses incurred by investors. However, in case of a shortfall, stockbrokersStockbrokersA stockbroker is an individual or company qualified enough to trade securities in the financial markets on behalf of financial institutions, individual and institutional investors, and organizations. They can work either independently as a professional trader or broker-dealer or associate with a brokerage firm.read more notify the traders via margin callsMargin CallsA margin call occurs when the stockbroker notifies the trader about the brokerage account balance falling below the minimum maintenance margin.read more, asking them to renew the balance to ensure the services continue.

Managing Spread Betting Risks

Investors can go for standard stop-loss ordersStop-loss OrdersStop-loss order is an advanced computer-activated trade tool that is primarily used to execute a trade for a certain stock if only the predetermined price-levels are attained while trading, i.e. it sells a specific stock when it is triggered and is useful for reducing the investors' loss burden.read more to mitigate the risks associated with a spread bet. Choosing this option will mean closing out a trade that is likely to incur losses for traders. Here, as soon as the market crosses a particular price level, the deal automatically closes at a level that is less harmful to them. It is a great alternative for a highly volatile market.

Managing Spread Betting Risks

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Another option to reduce the risk of spread betting is initiating guaranteed stop-loss orders. It ensures the closure of a trade at the exact value set by investors/traders irrespective of the market conditions. However, this alternative is not free of cost. To have this opportunity, participants have to pay an additional charge to brokers.

ArbitrageArbitrageArbitrage in finance means simultaneous purchasing and selling a security in different markets or other exchanges to generate risk-free profit from the security's price difference. It involves exploiting market inefficiency to generate profits resulting in different prices to the point where no arbitrage opportunities are left.read more is the next option. Two-way betting can save traders from falling prey to a spread bet risk. They get such an opportunity when the price of an asset is different in different markets. This way, they can buy it in one market at a lower price and simultaneously sell it in another at a higher cost.

Example

ABC Ltd is currently trading with an ask price and a buy price of 19504 ($195.04) and 19519 ($195.19). Trader X anticipates that the share prices of ABC Ltd might rise in the near future. Hence, he decides to buy more of these shares for $10 per change point in 19519.

If the company’s share price rises, Trader X will choose to close his trade as soon as the ask price touches 19549. Since the market increases by thirty points, Trader X will earn a profitProfitProfit refers to the earnings that an individual or business takes home after all the costs are paid. In economics, the term is associated with monetary gains. read more of $300, excluding all the extra costs.

Spread Betting Example

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On the other hand, if the market moves downwards to an ask price of 19449, Trader X loses. Since the market decreases by seventy points, Trader X would incur a loss of $700, exclusive of additional costs.

Advantages & Disadvantages

A spread bet has numerous advantages. However, it is not devoid of the disadvantages. Let us have a quick look at the pros and cons of spread betting:

PlusMinus
Tax-efficient (For example, no stamp duty or capital gains tax is applied in the UK spread betting).Frequent margin calls as traders forget to stick to their deposited amount and move beyond limits while betting.
Commission-freeBetting firms aim at widening traders’ spreads, triggering guaranteed stop-loss orders, which involve huge trading costs.
Both short and long options are available
Traders cannot lose more than what they have deposited with brokers.
Open for all markets, including forex, currency pair, commodities, cryptos, etc.

Frequently Asked Questions (FAQs)

What is spread betting?

It is a trading strategy where investors/traders do not own an asset and trade in a traditional way. They, instead, speculate on the rise or fall of the price of a security and accordingly place a bet against the future price movements in the markets. If the speculation turns out to be right, it’s a gain for investors. Else, it’s a loss.

Is spread betting taxable?

A spread bet is tax-free as it is considered a speculative bet and not an investment. Therefore, there is no stamp duty charged or Capital Gains Tax (CGT) applied to it.

How does spread betting work?

Investors willing to spread bet connect with brokers and open a position in exchange for a spread, the difference between an asset’s ask and bid price. This acts as a brokerage charge. The investors deposit a small margin to start with and also have a maintenance margin as the maximum limit to which they can keep betting. Once they have their funds arranged, they place a bid.
They can either choose to go short (sell bet) or go long (buy bet), considering the market’s direction. So, for example, if traders expect the market to go up, they can click on buy, while if they think the market will go down, they can click on the sell option.

This is a guide to what is Spread Betting & its meaning. Here we explain its risk mitigation mechanism, components, pros and cons, and examples. You can learn more from the following articles –

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