Gamblers might concede that one of the ‘golden’ rules of gambling is, “never bet more than you can afford to lose.”
So, are the leveraged stakes of spread betting a step too far or, alternatively, are they the best way to make money in this volatile environment?
For those who adopted a hold strategy on all their stocks throughout 2008, the results have not been pretty.
But anyone betting on the rises and falls in various sectors could actually have done very well. This is spread betting and the concept behind it is simply to make your money work for you.
Like it or not, spread betting is huge business. So, rather than just dismissing it I thought it might be useful to look ‘under the bonnet,’ as it were, to see how it works in practice.
Take a practical example. An investor thinks that the British Telecom (BT) share price is undervalued but set to rise. It is February and the spread betting price for April BT (expiring in April) is 144.145.
He decides to make an up-bet or buy at 145 for £5 per point. Thus for every point BT’s share price rises above 145 the investor makes a profit of £5.
However if it falls he will lose £5 for every point it falls below 145. Looking at it again another way, our investor can also bet on the price falling below a given figure and make the same profit.
But there is also a third option. If our investor wants to bet on a general share price movement he can deposit £1,000 and gain exposure to £10,000 worth of stock.
Obviously, such gearing works both ways. So while it is possible to make a lot of money this way it is also possible to lose a lot, depending on which way the bet goes.
You can bet on almost any financial instrument — shares, bonds, indices and sporting events to name a few.
Spread bets however have a time limit, which means that the bet will expire by a certain time and date.
Thus the very volatility that we are currently experiencing can be the spread betters’ friend, because the limited time span increases the likelihood of making the correct ‘call.’
Spread betting has some additional advantages and disadvantages. The proceeds, if you have made a profit, are tax-free. You can gear your potential profit. You can win by betting short and you have access to a wide range of markets, including foreign exchange deals.
Neither is there capital gains tax (CGT) on any profit. You can make small bets and thus reduce your exposure.
On the other hand, unless the investor places a guaranteed stop loss with the bet — meaning that the bet automatically closes when losses hit a certain level — you can incur very large losses should markets move against your position.
Then again, while you pay no CGT on any gain there isn’t, conversely, any loss relief either.
I know of at least five major firms offering a spread betting service and at least one of them offers an education programme for investors.
So, if you fancy you can predict what any of the indices or markets may do, then here is a place where you can test your theories.
Nicholas Watts is an independent financial adviser with Positive Solutions Financial Services which is regulated by the Financial Services Authority. To contact him, use the website www.realwealthmanagers.co.uk.