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Spread Betting - The Good, Bad & Ugly....
Spread Betting With Shares
Member Name: bonta
Spread Betting With Shares
Date: 28/07/07, updated on 29/07/07 (623 review reads)
Advantages: tax free, trade lots of markets from one account, gearing, commission free, credit facilities,
Disadvantages: danger of losing more than initial outlay, seen as gambling,
Spread Betting – How it Works
This is how spread betting works. Suppose you want to bet that the share price of Marks & Spencer will rise. Instead of investing, say, £7,000 to buy 1,000 shares at £7 each (paying the broker's commission and stamp duty), you buy a spread bet at £10 a point instead – this means that for every penny the M&S share price rises you will make £10. If the price of M&S shares rises by 10 per cent, your share purchase holdings will show a profit of £700 on your £7,000. But with a spread bet or CFD, your initial deposit 'on margin' will typically have been just 10 per cent of the value of the shares, in this case £700. If the shares then rise by 10 per cent, you make 70 points at £10, which is also £700 -- so instead of a simple 10 per cent return, you've doubled your initial stake. The down side is that if the shares fall by 10 per cent, you lose your entire £700 outlay.
The Good, Bad & Ugly....
The taint of ‘gambling’ is probably what puts most people off spread betting, but running a close second is the belief that it is much riskier than normal investing.
You can see why the idea has taken root. Try investing £10,000 in a FTSE spread-bet with CMC Markets or IG Index, and contrast it with the same amount invested in a FTSE tracker. The spread-betters will use your initial stake as a 1 per cent deposit to open a position that is 100 times bigger. In other words, your £10,000 spread bet gives you £1m worth of exposure to the FTSE 100.
Suppose the FTSE 100 fell from 4800 to 4752. Those 48 points equate to a 1 per cent drop. Your exposure to the index is £1m, 1 per cent of which is £10,000. That means a 48-point fall in the FTSE would lose you your entire investment. On the plus side, a 48-point rise would double your money. But a 96-point fall over a few days would leave you owing the spread-better £20,000. The same principle applies to CFDs.
By contrast, a 1 per cent rise or fall in the FTSE would leave your index tracker fund just £100 better or worse off. You are far less likely to lose your head in such circumstances.
But it's not all bad news. First, spread betting on individual shares tend to have less extreme financial leverage than that offered on indices like the FTSE 100.
Second, you are in control of the risks you take. You always know the margin (also called gearing or leverage). Therefore, you can calculate the exposure you want to commit to in advance. So choice is not between £10,000 in a FTSE tracker or £10,000 on a spread bet that will give you exposure of £1m. Your choice is between £10,000 in a tracker and £100 on a spread bet, with the remaining £9,900 in a high-interest savings account.
This second option gives you the same exposure to the FTSE as investing all your money in a tracker, and you get the certain return of interest on that £9,900. However, it is not the free lunch it may seem. Remember that your deposit (in this case £100) is used to gear up the total investment. But you pay for that privilege. Spread betting firms will charge you interest on any position left open overnight. For smaller clients, this will usually be 2 or 3 basis points above UK interest rates.
An ideal website to visit, to start learning about spread betting is www.financial-spread-betting.com who offer a very comprehensive quick-learning page on their site.
Summary: Some are put off spread betting because they think its risky but put aside these prejudices and....