What Is Spread Betting And How Does It Work?
The stock markets permit you to buy and sell in equities, futures, options, etc. In all these trades, you take a view on the movement of the security in question and take a position. However, there is also another way of doing this, i.e. betting on the spread.
Normally, what do stock market traders discuss during lunch? In colloquial Gujarati, it would be something like â€œBajaar kyan bandh thaseâ€, meaning â€œat what level will the Nifty or the Sensex closeâ€. Something like this can form the basis for a spread trade. For example, you can bet on the spread between the last traded price of the Nifty and its closing price. You can also bet on the spread between the Nifty spot and Nifty futures or between futures of two different months. You can also bet on the arbitrage spread on the Nifty versus the arbitrage spread on the Bank Nifty. Bottom line is that the spread betting opportunities are humungous.
A spread trade market just requires a person who wants to take a bet and another party willing to underwrite it. While neither the NSE nor the BSE permits this kind of spread betting, this is a very popular trend globally.
What Exactly is Spread Betting?
Spread betting is a technique of betting on the movement of a financial market without having to buy the underlying investment itself. Like the name suggests, it is a bet and not an investment. It is comparable to betting on whether it will rain on a given day or not? Spread betting is common in the UK; in India, an individual can open an account with a spread betting firm subject to regulatory approval. One can effectively bet on things like the rise or fall of a share index such as the Nifty, Sensex, FTSE 100, CAC, Dow Jones, Nikkei, etc.
Spread betting can also be extended to equities, sectoral indices, commodities, currencies, interest rates, and even to exotic assets like Bitcoins. When you spread bet, you take a position based on whether you expect the price of an instrument to rise or fall in value. You will make a profit or loss based on whether or not the market moves in your chosen direction.
How Does Spread Betting Actually Work?
With spread betting, you don't buy or sell an underlying asset (for e.g., a share or a commodity), instead, you place a bet based on whether you expect the price of an index or commodity to go up or down. If you expect the value of a share or commodity to rise, you would open a long position (buy). Conversely, if you expect the share or commodity to fall in value, you would take a short position (sell). Your profit or loss will eventually be a multiple of the actual movement in price based on your stake/leverage taken.
In spread betting, you buy or sell a pre-determined amount per percentage point movement in the underlying index or commodity that you are trading. For example, a £5 per point spread bet means that for every basis point (1/100th of 1%) that the price of the instrument moves in your favour, you will gain multiples of your stake times the number of points by which the instrument price has moved in your favour. Assume that if £5 represents a 1 basis point movement in the index in a spread bet, then a 4% (400 basis points) movement in the underlying index would fetch you a profit of £2,000 (400x £5).
On the other hand, you will lose multiples of your bet for every point the price moves against you. However, in spread betting, you can end up losing more than your capital and even get wiped out.
High Leverage=High Risk
Spread betting is a leveraged product, which means you only need to deposit a small percentage of the full value of the spread bet in order to open a position. This is also known as trading on margin. While margin (or leveraged) trading allows you to maximize your returns, losses are also maximized as they are based on the full value of the position. One can argue that this is like buying and selling futures, but in futures you have an underlying stock or index. In spread trading, there is no underlying and you only bet on the movement.
Many investors choose to spread bet on the financial markets as spread betting offers a number of benefits over buying physical shares. Firstly, it is not closely regulated. Secondly, the leverage is much higher in spread trading compared to trading in shares. Thirdly, in other countries, spread profits are not taxed, but, in India, such profits could be taxed as speculative profits since there is no intention to take delivery. Also, such losses from spread betting can only be written off against speculative profits for tax purposes.