What is Spread Betting?
Spread betting is more or less a type of betting on the future movements in the market, and it is also considered as a derivative strategy, the participants of which does not really have the ownership of the assets that they are using for betting purposes, on, in other words, it can be learned as a form of betting that is all about placing a bet on the shifts in the prices of a stock or a commodity.
It is all about betting in the movement of security with respect to its price. Generally, two prices (ask and bid price) are quoted by a spread betting company. The participants (investors) then bet if the price of a particular asset will be higher than 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 or lower than its 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.
How does Spread Betting Work?
Spread betting work through 3 varied components. The first one being “the spread” that happens to be the charge one pays to open the position. The second one being “the best size,” which determines the total amount of capital that is actually put up. The third and last one being “the bet duration,” and it determines the duration for which the position shall remain open before it actually expires.
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For eg:
Source: Spread Betting (wallstreetmojo.com)
Example
- For example, ABC Ltd is currently trading with an ask price and a buy price of 19504 ($195.04) and 19519, respectively. It might happen that Trader X anticipates that the share prices of ABC Ltd might rise in the nearing days, and accordingly, he decides to buy more of this company’s shares for $10 per point of change in 19519.
- If the share price of the company will rise, Trader X will choose to close his trade as soon as the ask price touches 19549. Since the market is now increased by thirty points, Trader X will earn a profit of $300, and this excludes all the extra costs.
- However, if the market would have sloped downwards to an ask price of 19449, then Trader X would have earned a significant amount of losses. Since the market has decreased by seventy points, Trader X would have earned a loss of $700, that too exclusive of additional costs.
Features
The features of spread betting are provided and discussed below:
#1 – Short Trading and Long Trading
It allows the participant to make speculations with respect to the market that is decreasing and increasing in value. This enables the participant to make appropriate decisions of keeping or getting rid of the securities with the rise and fall in its values.
#2 – Leverage
Spread betting has leverage that works as a fantastic feature. This is because of the fact that it enables the participants to enjoy full market exposure on account of the slightest of the underlying market costs.
#3 – Margin
Deposit margin and maintenance margin are the two types of margins that are considered during spread betting. The deposit margin is concerned with the primary funding that is required to initiate the position, while the maintenance margin is the additional fund that would be required to maintain the open position.
Purpose
The purpose of spread betting is to incentivize betting for both the sides of the competition. It helps in determining the parameters for wagering and creates an active market for not just one side but actually for both sides of the competition, i.e., binary wagers.
Advantages
- It allows capital to move further and that too, with leverage. This means it can help a trader in taking his money further as it enables him to initiate a position that is way bigger than his opening deposit.
- It enables the traders to pre-decide if they want to go long or short based on analyzing the behavior of the market. This means if a trader believes that the market is going to rise, then he would choose to go long and vice-versa.
- It ensures the traders that the profits they make in the process are exempted from capital gain taxes and stamp duties.
- Spread betting enables traders to trade in a variety of markets.
- The traders can also choose to hedge a share portfolio by making speculations on an asset that moves in a direction totally different in comparison to the shares owned by them.
- This enables the traders to trade without having the need to pay commission.
- This also enables traders to have access to trade outside regular trading hours.
Disadvantages
One of the prominent drawbacks of spread betting could be margin calls. Traders who are not of leverage mechanism might end up taking positions that are way larger for their accounts, and this could pave the way for margin calls. It can also carry a huge level of risks if not traded with caution.
Limitations
Wide spreads are one of the prominent limitations of spread betting. During volatile periods, spread betting companies tend to enlarge their spreads. This can result in the rise of trading costs as the 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 shall get triggered. Traders should be careful about trading and placing orders when it comes to spread betting and should often look for the company’s economic reports and earnings announcements.
Conclusion
Spread betting is a type of wagering that is introduced with the purpose of creating an active market for both sides of the competition. With this, traders can gain exposure to different types of markets by merely depositing a minimal percentage of the overall value of the trade, and if the market moves as they expected, then they can earn profits. The profits earned from spread betting shall not be charged for capital gains tax and stamp duties. In fact, the traders will not have to pay any sort of commission for trading.
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