Spread-Betting Basics for Your Investment Portfolio
Betting on financial markets has boomed in the last decade. Many British companies, such as IG Index, lead the world with a whole heap of new innovations and cutting-edge websites. Without doubt, these big spread-betting firms make the job of betting on financial indices incredibly easy and relatively painless. Adding to the attraction, these bets on the direction of major markets are tax-free in the UK, which makes a big difference compared to traditional structures where lucky investors pay tax on capital gains.
Note: This tax-friendly regime for spread betting exists in the UK for a reason: spread betting on financial markets is precisely what it says – betting, not investing, and a 2012 overhaul of UK gambling tax eliminated capital gains and stamp taxes for gambling winnings. In the US, however, gambling winnings are fully taxable and must be reported on tax returns.
Before you toss your portfolio headfirst into the spread-betting pool, heed these two warnings: one, spread betting is gambling, which means a very good chance exists that you’re going to lose money most of the time. In fact, you can end up losing a lot unless you’re careful and diligent, which means understanding exactly what you’re getting into.
Two, spread betting in financial markets is illegal in the US. Although some countries that ban spread betting allow their residents to set up online accounts with UK spread-betting companies, the US isn’t one of them, courtesy of the 2006 Unlawful Internet Gambling Enforcement Act.
Working a long/buy trade
You make a long trade as follows. Imagine that shares in oil giant BP are currently trading at 430–430.5 pence. As the investor, you consider two scenarios:
The shares are going to rise in price: In this scenario, you decide to put down a bet at 430.5 at £10 a point.
The shares are going to fall in price: In this scenario, you decide to put down a bet at 430 at £10 a point.
If BP’s shares rise in value to 435–435.5 pence a share, your first scenario obviously succeeds. You close your position with a sell bet at 435 and make a profit of £45 (4.5 points x £10). With BP shares up, the second scenario makes a loss: if you sell out at 435, you make a loss of £50 (5 points x £10).
Trying a short/sell trade
If you decide to go short, you expect the share price to drop in value, so you sell at the bid price with the intention of buying at a later date when the stock is cheaper.
Imagine that BP shares are being offered at a spread of 450–451 pence and you think that price will fall very soon. You decide to sell at the bid price of 450 pence and you bet £5 per penny on that downward movement. A week later BP’s shares do fall in price and you’re offered 430–431 pence. You close your position by buying at the offer price of 430 pence. Your profit is worked out as follows:
450 – 430 = 20 x £5 = £100
But you’ve left your position open for five working days (a week) and so you need to calculate your rollover costs and deduct these from your profit.
To do so, you take the total trade consideration and multiply it by the overnight financing rate (2.5 per cent + the London Inter Bank Offered Rate (LIBOR) (the average interest rate for lending): call that 1 per cent for this example. You divide this by 365 and multiply by the number of days you held the position (5).
So if in total you placed an order worth £450, your calculation is:
£450 x 3.5 per cent = £15.75 / 365 x 5 = £0.21
Therefore, your total profit is £100 – £0.21 = £99.79.