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Key facts
- Spread betting is similar to stock market trading, but one key difference is you aren’t buying assets in a spread bet, meaning opening costs are low.
- Since you don’t own the asset, you don’t get to take advantage of dividends in spread betting.
- Spread betting is not legal in some areas, including the United States.
Spread betting is a different twist on investing that many find more similar to wagering on sporting events or other futures than to trading in the stock market. It was developed in the 1970s, and it resides in the middle ground between the two, with similarities and key differences from both.
Which is better? Much of it depends on personal preference, but there are definitely benefits and drawbacks of each way of playing the markets.
What is Spread Betting?
Spread betting is a derivative strategy, meaning you are speculating on the future price of an asset, not buying and selling the asset outright. You are betting on whether the current price of a stock, commodity, or other asset will increase or decrease in the future. If you are correct, your spread bet pays off. If the price moves in the opposite direction you predicted, you lose money.
In this aspect, it is similar to betting on a sporting event. You have no ownership stake when you bet on a basketball game. You’re watching from afar and putting money on a prediction of what will happen.
The difference is, with a traditional bet, you know how much money you are risking upfront and how much you stand to win, based on the published odds for your bet. With a spread bet, the amount you might win or lose is unknown and goes up depending on the magnitude of the change. If you predict the change correctly, the more the asset price changes in that direction, the more you win. If you’re wrong, the more it moves, the more you lose.
How It Works
Let’s say you’re taking a spread bet on the stock of company AAA, which currently sells at $38. Based on your research, you’ve determined it is likely to increase in the near future. With a traditional stock trade, you would buy a certain number of shares of AAA, putting that money down at the start, and hold them until you are ready to sell, hopefully at a profit.
With a spread bet, you would simply place a bet that AAA will increase, and you’d specify how much you’re betting per “point” (or cent of share price, in this example). So, we’ll say in this example that you took a spread bet on AAA increasing at $10 a point.
Turns out, you were right. AAA’s price increases to $40. So you’ve won your bet, and your payout is $2,000. (The price went up 200 points—cents—and you get $10 per point.) If it went up from $38 to $50, you’d win $12,000 (1200 points x $10 per point).
On the other hand, if it fell to $35, you’d lose $3,000 (300 points x $10 per point).
Obviously, you could risk losing substantial sums of money ($38,000 in this example) if the price goes to 0. For that reason, most bettors use stop-losses, which specify the price at which your bet will be terminated. So, if you set a stop-loss at $33, that means the most you could lose would be $5000. When the price hits $33, your bet ends.
Benefits of Spread Betting
The benefit of spread betting is that it’s generally easier and lower cost than actually trading stocks. You only need to put down a small portion of the stock price to make your initial bet, instead of buying shares. Fees, commissions, and taxes are also generally lower on spread bets.
The stop-loss also helps manage your risk. In a stock trade, if the stock price goes to pennies, you risk losing your entire investment.
Benefits of Stock Trades
In a traditional financial trade, you own an asset, either a stock or a commodity. With stock ownership, there are certain privileges, including voting privileges. You also can take advantage of dividends that the stock may pay. None of that is available with a spread bet. You are “watching from the stands” and don’t own anything.
Drawbacks of Spread Betting
One issue with spread betting is that it’s not legal everywhere. Most notably, it’s illegal in the United States, because of the risk of enormous losses. So it could be difficult to engage in it for Americans who are not planning to travel abroad.
