How does spread betting work?
Let's start by considering a more traditional form of betting, like betting on horse racing.
When you spread bet, the degree to which you’re right or wrong determines your profit or loss
You might be used to seeing bet prices or 'odds' such as 2/1 or 3/1 (two or three-to-one). This is known as fixed-odds betting, because the amount you stand to win or lose is fixed according to the odds of your horse winning. If you bet £10 on Red Rum at 2/1 and Red Rum comes in first, you’ll win £20 (plus your original £10 stake back). If Red Rum doesn’t win, you lose your £10 stake.
Now, what if you were betting not on whether Red Rum wins, but on the time it takes for him to complete the race?
You could do this as a spread bet, staking £1 for every second over three minutes that it takes for Red Rum to finish. This means if he goes on to run the race in three minutes 20 seconds, you would win £20. And for every additional second you would win another pound.
However the opposite is also true. If you’re wrong and Red Rum finishes the race in less than three minutes, then for every second below three minutes you would lose a pound. So if he finishes in, say, two minutes 40 seconds, you would lose £20, and for every second faster you would lose another pound.
This – winning or losing more according to the degree to which you’re right – is the essence of spread betting.
Financial spread betting
While it’s possible to spread bet on sporting events, and even on things like house prices and the general election, by far the most popular form of spread betting centres around finance and the value of 'financial assets'. These 'assets' can be:
- Shares, like Apple or BP
- Currencies, like the euro (EUR) or US dollar (USD)
- Commodities, such as gold, oil or sugar
- Stock indices that track the performance of a group of shares, such as the FTSE 100, or Nikkei 225
- Other financial products such as interest rates, government bonds, options, etc
At any one time, each of these assets is worth a certain amount of money. This is its price or market value, and it changes over time.
Today one share of Apple might be worth $120, but tomorrow its value may have risen to $123. Similarly, one euro could be worth around 75p this week, but in two months’ time it might have dropped to 70p.
Financial spread betting is simply betting on how the value of a financial asset will change in the future. In most cases, you’re betting on whether it will rise or fall. If you think the price of the asset will go up, you ‘buy’. If you think it will fall, you ‘sell’.
The mechanics of spread betting
When you spread bet, you stake a certain amount of money on each unit of movement in the price of the financial asset. This unit changes depending on the asset in question, so for Apple it might be a $0.01 movement in the share price.
You stake money on each unit the price of the financial asset moves
You could bet, say, £1 on each $0.01 increase in the price. So if the price moved up by $0.09 you’d make £9. If it dropped by $0.09 then you’d lose £9.
Unlike the horse racing example above, most forms of financial spread betting are not dependent on the specific outcome of a particular event. This means, in most cases, you can choose when to close your bet – allowing you to decide when to take your profits, or cut your losses.
Let’s say you've been reading about Tech Company X, soon to be releasing a new mobile device that you believe could challenge the current leading smartphone. Here’s how you might spread bet on the share price of that company.
Tech Company X’s share price currently stands at 80p. If sales of the new device are good, its share price could rise dramatically, so you decide to bet £5 for every pence it increases.
As you predicted, the new device is flying off the shelves and the share price has gone up to 90p. At this stage you’ve made £5 for each pence gained, so £50 in total (£5 x 10).
Sales continue to be stellar for the new device and the share price of Tech Company X hits 105p. You’ve now made £125 (£5 x 25) and you decide to close your bet and take your profit.
It’s a good thing you did, because a technical glitch in the product means all the new devices have to be recalled at huge cost to the company. The share price plummets to 60p in a short space of time. If you’d kept your bet open, you’d be looking at a £100 loss at this point (£5 x -20).
How does this differ from financial trading?
Of course, instead of spread betting in the above example, you could have just bought – and then sold – the actual shares themselves.
You never need to own the asset that you’re betting on
The difference with spread betting is you never need to own the asset you’re betting on. It is just a bet on the movement of a price.
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