Derivatives Trading

Derivative Trading: Betting on the Spreads

Spread betting is perhaps the simplest form of derivative trading around and is certainly the most tax-efficient. Spread bets allow you to bet that the price of an underlying asset (a share, commodity or index) will rise or fall. This means that you could hedge your existing holdings, perhaps betting on a fall in the FTSE 100 to offset the risk of a fall in your UK portfolio.

You could also use spread betting to speculate on your view of an underlying asset (a share price or index level, for example), either trying to profit from a falling price or hoping to make enhanced gains from a rising price. Betting on falling prices is known as ‘going short’, whereas betting on rising prices is called ‘going long’.

The great advantage of spread betting is that gains are totally free from tax. This means you do not have to pay capital gains tax at 40 per cent (for higher-rate taxpayers) on gains over the annual exempt allowance, which is currently £9,200. On the other hand, you cannot offset any losses from spread betting on gains made elsewhere.

Spread betting is also very flexible and allows you to choose risk levels to suit your own circumstances. This is because the higher the degree of gearing (magnification) you use in the hope of boosting returns, the more your profits or losses will be enhanced.

For example, you could set your gearing level at 10 times (10-1), where your profit or loss would change by 10p for every point move in the FTSE 100 index. If you were more confident (or could stand to make a larger loss), you could gear up by one thousand times, where every point move by the FTSE 100 would create a £10 change in the value of your bet.

Although spread bets can be kept open for several months, you must leave a deposit (known as margin) with your broker. A typical minimum margin level would be around £2,000. However, if you are making a loss on your position, you must top up the margin every day – although you do not have to keep the bet open for as long as you intended at the outset, of course.

If you bet on a rising price, you can make unlimited enhanced profits. And, if the market moved against you, your losses would be enhanced but capped, as the underlying price could fall no further than 0p.

On the other hand, if you bet on a falling price, your potential profits would be enhanced but limited. And if you bet on a falling price and it rose, your losses could be unlimited – hence, the need to top up your margin (on any day you lose money) acts as a break and could force you to close a disastrous position, instead of racking up enormous losses, which would only be settled at the close of the bet.

You can also restrict your potential downside by setting a stop-loss with your broker. This would close your position, if the underlying price moved against you and past a predetermined level (falling 10 per cent below its opening price, for example).

Stop-losses should not be set too tight, though, as the underlying price could move against you before changing direction, so you do not want to be closed out too early. You can also use a trailing stop-loss, which keeps the same percentage-point distance but follows a rising underlying price up in a bull market, enabling you to lock-in some gains.

Spread-betting providers set their own spreads, which are not necessarily the same as the bid price and offer price for an underlying share. So spreads can be set much wider for spread betters (although, in theory, competition between brokers should keep spreads fairly tight).

In reality, though, underlying spreads on some shares can be as wide as 5 per cent, although they are normally much tighter for large, frequently-traded shares. This is because the wider the spread, the larger the movement required by the underlying price for the bet to pay off.

You go long with a spread bet by ‘buying’ the underlying asset at its offer price and close it by ’selling’ at the bid price. To go short, ’sell’ the underlying asset at the bid price and close by ‘buying’ at the offer price.

The only difference is in foreign-exchange trading, sometimes known as forex, which is a form of spread betting. Currencies are always shown in pairs and you buy the one you think will perform better. For example, if you think the dollar will fall relative to sterling, you need to buy sterling (versus the dollar).

To conclude spread betting is great fun, and almost anyone can enjoy the odd bet now and again. But if you want to make money from spread betting, then it must be taken seriously and a disciplined and tactical approach is required.

About the Author

Information on lop eared bunnies can be found at the Bunny Facts site.

Ins and Outs of Derivatives Trading – Part 1

E-mini Index Futures Trading Cd 1 -2010 $44.95 Get more bang for your buck through the leverage of E-minis! Mike Mc Mahon takes you through the ins and outs of trading this highly liquid financial instrument. E-Mini Futures contracts are one the fastest growing segments in electronic trading today. A one point move in the S&P’s will yield a $50.00 profit on 1 contract – and the S&P moves 7 to 10 points every day! Join Online Trading Academy…

Option Screening: Finding Profitable Trades DVD with Lawrence Cavanagh $49.99 Hedge your risk and reap healthy returns with option spreads, no matter how the market performs! Drawing on his years of experience as a well-known options expert, Lawrence Cavanagh teaches you how to successfully employ a variety of profit-enhancing option spread techniques. Protect yourself against the uncertainties of the markets by understanding how to use volatility to your advantage. Focusin…

Futures Trading: Professional E-mini Trader Library- 2010 $250.00 This incredible E-mini trading library includes the following CDs: E-Mini DERIVATIVE FUTURES-WITH MIKE MCMAHON! E-Mini’s ADVANCED STRATEGIES. TECHNICAL ANALYSIS FOR THE PROFESSIONAL TRADER (part 1, II, III) FIBONACCI- Use Mathematical Magic for Better Profits from Each Trade. STRESS MANAGEMENT – Defeat the Hidden Killer and Be a Profitable and Healthy Trader. 10 LAWS OF RISK MANAGEMENT….

Moroccanoil Oil Treatment For All Hair Types (select option/size) Moroccanoil has unique quality of instant absorption into hair, creating an instant shine and long term conditioning without leaving residue….

Olay Total Effects 7-in-1 Anti-Aging Daily Moisturizer, 1.7 Ounce Total Effects Daily Moisturizer provides the total anti aging power of hydration fused with vitamins and antioxidants for visibly younger-looking skin that looks more resilient to aging.Smooth on clean face and neck. Gentle enough for everyday use, and designed to replace your moisturizer and specialty skin care products.Total Effects fights 7 signs of aging fine lines and wrinkles, rough texture,…

Physicians Formula Healthy Wear Tinted Moisturizer, SPF 50, Ivory to Fair 7066, 1 oz. $14.95 Lightweight hydration; natural coverage & finish. Since 1937. Protects + prevents + restores. Healthy = beautiful. Delivers maximum, broad spectrum UVA/UVB protection while providing sheet and natural-looking color. Beauty’s response to a thinning ozone layer. Protects – SPF boosters and mineral-based titanium dioxide & zinc oxide provide SPF 50 protection and help skin stay protected longer witho…

The All New Atlas Talking English, Arabic Dictionary S523 (23 Dictionaries)…2012 $230.00 Atlas Modern Dictionary (English-Arabic) (Unabridged Encyclopedic) 2011 with thousands of new words and useful lingual information such as examples, derivatives, synonyms, antonyms, etymology, illustrated images and many more. Atlas Modern Dictionary (A-E) 2010 includes Arabic words and phrases with their Arabic and English explanations. The American Heritage Dictionary of the English language 2…

The Big Short: Inside the Doomsday Machine $7.70 Who saw the real estate market for the black hole it would become, and eventually made billions of dollars from that perception? And what qualities of character made those few persist when their peers and colleagues dismissed them as Chicken Littles? Out of this handful of unlikely – really unlikely – heroes, Lewis fashions a story as compelling and unusual as any of his earlier bestsellers, provi…

Option Volatility & Pricing: Advanced Trading Strategies and Techniques $32.67 One of the most widely read books among active option traders around the world, Option Volatility & Pricing has been completely updated to reflect the most current developments and trends in option products and trading strategies. Featuring: Pricing models Volatility considerations Basic and advanced trading strategies Risk management techniques And more! Written in a clear, easy-to-understand f…

Traders, Guns and Money: Knowns and unknowns in the dazzling world of derivatives Revised edition (Financial Times Series) $11.85 Traders Guns and Money is a wickedly comic expose of the culture, games and pure deceptions played out every day in trading rooms around the world. And played out with other people’s money. A sensational insider’s view of the business of trading and marketing derivatives, this revised edition explains the frighteningly central role that derivatives and financial products played in the global finan…