Imagine you put £10 on Liverpool to win the league at 10/1 with a fixed-odds betting company. If Liverpool failed to win the league, then the bookmaker would simply pocket your tenner. On the other hand if Liverpool were triumphant, they’d owe you £100 (plus your £10 stake back).
Most spread betting providers do not profit from their clients’ losses in this way – they’re not taking a position that effectively opposes yours. Instead, they make money on every bet that’s placed by taking the spread – regardless of whether you end up with a profit or a loss.
They also have a number of other ways to make money, and to protect themselves against the risk of loss.
This is where providers match their customers’ bets by taking real positions in the underlying market. In doing so they reduce their own exposure to risk and protect themselves in the event a bettor makes a substantial win.
Let’s look at an example.
Imagine that shares of Barclays are currently trading at a price of 228/230 in the underlying market (since the underlying market has a spread of its own between the buying and selling prices). Your provider has added a further spread either side of this to create their own price – we’ll assume it stands at 227/231.
Now, say that you wanted to place a ‘buy’ bet at £500 per point. You would do so at your provider’s price of 231. Should the price of Barclays subsequently skyrocket, then you stand to win a substantial amount of money – an amount your provider may not easily be able to afford.
To protect itself against this eventuality, your provider might decide to hedge the bet. This means it would go into the market and simultaneously buy an amount of shares in Barclays that would give the equivalent exposure of £500 per point. However, it could do so at the current market price of 230, which is an advantage of one point over the price you opened your bet at.
After a few weeks, let’s say Barclays’ share price is being quoted like this:
If you wanted to close your bet you would need to ‘sell’ at the provider’s price of 247. Your provider, on the other hand, would close the hedge by selling its shares in Barclays at the market price of 248 – another one point advantage.
In this scenario you bought at 231 and sold at 247, which gave you a profit of £8000 (£500 x 16 points). However, your provider bought at 230 and sold at 248, meaning it made a profit of £9000 (the equivalent of £500 x 18 points). By hedging the bet the provider is able to pay your £8000 in winnings, but has still made an additional £1000 by capturing one point on the spread (worth £500) on opening and closing the deal.
The provider will make a profit through the spread regardless of whether your bet wins or loses. If the share price of Barclays had fallen, then any losses you made would be used by your provider to counter the loss it made on its own investment. However, due to the spread, the additional £1000 would still have been captured.
Of course, different providers will have different policies. While some will strictly hedge every bet like for like, most (including IG) take on at least some degree of risk. One reason for this is that the cost of hedging small bets will often offset the benefit of the hedge, so the provider is more likely to just let the bet run unmatched.
Another reason that spread betting providers are unlikely to hedge each and every bet is that sometimes there is simply no need to. This is because clients – especially those dealing in highly liquid markets – will usually make opposing deals that effectively hedge the bets automatically.
Imagine that GBP/USD is currently trading at 1.5204. A provider has wrapped a spread around this and offers it at a buy price of 1.5205 and a sell price of 1.5203.
Say that client X sells GBP/USD for £10 per point at 1.5203, but at the same time client Y buys GBP/USD for £10 per point at 1.5205. The provider is exposed to no risk in this scenario as the two bets have effectively cancelled each other out. Any money that needs to be paid to the winning bettor will be covered by the losses of the other – it makes no difference in what direction the market moves.
Meanwhile the provider will make a £10 profit through the spread from each client, both when they open their bets and again when they close them.
Overnight funding and extra fees
The spread is not the only fee that providers will require for their services. For instance, most will charge you to hold a daily bet overnight, collecting additional funds for each day your position remains open.
Providers will also usually charge you to use certain features that are designed to either enhance or safeguard your spread betting. For example, there is generally a fee to pay if you want to attach a guaranteed stop to your position to protect yourself from slippage – though some providers will only charge you if your stop is triggered Similarly, you might be required to pay extra if you want to make use of advanced charting packages.
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