Spread betting is becoming an increasingly popular form of FX trading. Its proponents are hoping it will grow as a risk management tool, too.
By Anita Hawser
Its initial popularity—and notoriety—may have been among sports gamblers, but spread betting is rapidly developing into a popular alternative investment medium. Mention the phrase “spread betting” to some FX trading providers, though, and you may get a frosty response. They prefer to talk about CFDs, or contracts for difference. “Spread betting implies there is a link to gambling,” says Rob Woolfe, head of FX at UK spread-betting firm ETX Capital, but he adds that the typical spread better has more of an informed opinion than just flipping a coin.
Spread bets are typically a bet on whether the price quoted for a particular financial product is going to go up or down. The amount of money that is made or lost is based on the spread—or the difference between the buy and sell prices. While the name and the history of spread betting carry the whiff of gloomy smoke-filled rooms and the quiet shuffle of stacks of used bills changing hands, Woolfe says spread-betting firms provide a “professional vehicle” for all kinds of investors to trade—and the activity is regulated by the Financial Services Authority (FSA). Simon Denham, managing director of Capital Spreads, the spread-betting unit of London Capital Group, points out that the average client on its platform typically bets £1 or £3 and in a year may spend only £1,800 ($2,850)—hardly the behavior of a prolific gambler.
Denham and others maintain that there is relatively little difference between spread betting and CFDs, which is what City-types are more likely to trade than an amateur sitting at home having a punt on whether the price of a stock or a currency pair is likely to move up or down. “CFDs use exactly the same trading systems as spread bets and the same outputs,” says Brian Griffin, managing director of spread betting and CFDs at forex broker FXCM. “They are just presented differently to the client at the front end.” Woolfe says the main difference is that profits earned on CFDs are not tax-free, which is one of the main attractions of spread betting in the United Kingdom, where it is particularly popular.
UK spread-betting firms are secretive about their daily transaction volumes, but suffice to say, given its various advantages, including the tax breaks, spread betting is becoming increasingly popular among both professional and amateur traders. FX is the second most popular spread-betting product after stock market indexes. (Virtually any product from sporting events to commodities, stock market indexes and FX can form the basis of a spread bet.)
FX spread betting accounts for more than 50% of ETX Capital’s web business. And in the current economic climate, where stocks and shares have performed poorly, “FX is just not going to go away,” says Denham of Capital Spreads, adding that business on its spread-betting platform increased by 20% to 25% in the first six months of this year. In the UK the most heavily traded spread-betting FX products are euro/dollar and “cable,” or sterling/dollar.
“The typical profile of those that spread bet is a male, aged between 30 and 45 years,” says Woolfe, but he adds that his company’s client list includes chief executives of large companies trading their personal portfolios and fund managers who run multinational portfolios. The number of trades on ETX Capital’s spread-betting platform is increasing month on month, but as people have become more risk averse, the average deal size has decreased.
The proliferation of web-based technologies has made it easier for firms to roll out online spread-betting platforms so punters can click and trade instantly. But, as Woolfe points out, spread betting has been around for more than 30 years. The Internet turned spread betting into a truly retail product, as before 2000 spread betting was mostly a City product, says Denham. Brokers preferred to keep it that way, he adds, not wanting to have to deal with amateur traders on the other end of the telephone. However, a large majority of ETX Capital’s business is now conducted online instead of on the telephone. Spread betting has also become more popular as investors have become disillusioned with traditional stockbrokers, says Griffin of FXCM. “People have money they wish to speculate with, and with spread betting it doesn’t have to be a large amount.”
The Route To Respectability
Some believe spread betting needs to shed its gambling stigma in order to broaden its mass-market appeal by educating people about how it can be used as a serious investment tool within a balanced portfolio. “It is an amazing way of building a portfolio,” says Woolfe. “You only need to put down a small percentage of the overall contract value to fund your overall position.” The margin or deposit an investor needs to fund a spread bet can be as small as 2%, for example, if it is a particularly liquid currency pair such as euro/dollar. Woolfe says it can also be a useful hedging tool for an investor wanting to protect an investment portfolio against any future movements.
That strength is also a potential weakness. Spread betting carries a high level of risk, and if an investor’s long or short bet on a particular currency pair, for example, goes against them, they can quickly end up in a deep hole. “The biggest problem is having exposure, which you need to square,” says Woolfe. “There is the potential for people with a large risk appetite to gear up very high [up to 500:1], but typically we would see deals in the region of 3:1 to 5:1 leverage.”
ETX Capital typically runs two trading books: one for clients that deal in large trades and one for smaller traders. ETX hedges all the bets in the large trade pool in the market so there is no exposure risk on the spread-betting company. “If the client wins [the bet], the spread-betting company also wins,” says Woolfe. “If they lose, the spread-betting firm also loses, but just a little less.” In the second trading book, or “B book,” ETX Capital assumes a certain level of risk, which is monitored by a risk committee to ensure it remains within established risk parameters. Most of ETX Capital’s deals go through the B book, and the exposure is executed in the underlying market.
Other firms take a different approach. FXCM hedges every trade in the underlying market, whereas Griffin says other providers that have not hedged all their positions can profit from a client if they lose a bet. At Capital Spreads all client funds are segregated, and Denham says it never makes margin calls. It is also deposit only (it does not give credit), and clients’ positions are stop protected. “Some people would say that’s restrictive of your trading, but by putting more restrictions on the trade, we are able to give a better price and better margins than our competitors,” Denham explains.
There are significant differences between spread-betting firms on prices and margin as well as daily rolling charges for positions that are held overnight. FXCM also tries to differentiate itself by saying it is not a “market maker.” So every time a client trades on FXCM, the trade is automatically piped to one of 10 banks.
While there are a plethora of online spread-betting platforms, Denham says that they are mostly “white labels” and that there are only eight true spread-betting firms in the world, which he narrows down to four serious providers: IG Index, City Index, CMC and Capital Spreads. FXCM is the newest entrant in the UK, and there could be more as spread betting goes mainstream.
“As we look forward and emerge from the crisis, more people will take up spread betting,” predicts Griffin of FXCM. “They may use spread betting to hedge exposures they already have in the market place.” It looks like spread betting may be about to finally shed its gambling stigma.