What is the difference between spread betting and CFDs?
Spread betting is often compared to its cousin – Contracts for Difference (CFD).
So what are the differences between spread betting and CFD?
Let’s start with a couple of similarities.
For those who have jumped on the spread betting and CFD bandwagon and been successful in their pursuits – they will likely explain these leveraged trading products as the key to amplify gains/losses and unlocking wealth for very little initial costs.
But we will admit that both spread betting and CFD are risky pursuits, especially for those who are more accustomed to traditional stock trading.
First off, what is a CFD?
A CFD is a very popular trading vehicle which allows the investor to ‘own’ a stock without actually physically investing in the share.
Doesn’t make sense? We will break it down.
CFD is margin traded, so the investor can actually take out the ownership position of the share without outlaying much capital at all. It is a cost-effective option for traders, but like spread betting, CFD followers can lose more than just their initial investment movement – because losses in the market are multiplied.
Both spread betting and CFDs allow you to trade on margin, both do not actually give you ownership of the stock and both are quite cost-effective in terms of costs involved with the transaction.
If you have a bearish view on a particular stock or other market, you may think you can only act on them if you already have a shareholding and wish to dispose of it. However, this is not the case: with a spread betting or contract for difference (CFD) provider, you can potentially profit even when the share price falls. This is known as short selling.
It should again be emphasised that these products are high risk, and can result in losing more money than you’ve deposited in your account. A good guiding principle in general is that you should not invest, trade or otherwise speculate with money you cannot afford to lose, and this is especially relevant when dabbling with spread bets or CFDs.
One way to lessen the risks associated with these accounts is to use guaranteed stop losses. This adds a little to the commission you pay to open the position, but gives you peace of mind knowing exactly how much you stand to lose should the share price go against you. I like Ayondo in this instance because they offer guaranteed stops free of charge.
Both spread betting and CFDs permit you to go long (i.e. buy) or short (i.e. sell). The main difference is that profits from financial spread betting are tax free, whereas those from CFDs would be liable to capital gains tax assuming you go over your annual allowance which is £11,000 in the United Kingdom. Assuming you have no other capital gains, that means you enjoy profits up to this amount incurring no CGT liability, regardless if you gain them from buying shares, online spread betting or trading CFDs.
Both spread bets and contracts for difference are traded on margin. This means that to open a trade of, say, £3 a point on the FTSE when the index is trading at 6,600 (this would be equivalent to an exposure of £19,800) you might only be required to deposit, say £60 or less. However, you would also need sufficient cash in your trading account to cover any losses. A 1% rise in the index would translate into a profit of £198 (excluding the spread). FTSE shares might require 5% initial margin while for the major currency pairs, this might be just 0.25%.
The other big difference is stamp duty. Neither spread betting or CFDs attract a stamp duty charge, which represents a saving of 0.5% per transaction. This is especially relevant when dealing with large orders.
What’s an example of going short with a spread bet?
Company X is currently trading at around 500p a share. You think it’s overpriced, and decide to go short. You want your exposure to be £2500 and you place a guaranteed stop loss at 550p.
With a spread bet, you specify an amount per point. As you want an exposure of £2500, the £ amount per point you wish to risk is 2500 / 500 = £5. This means for every penny the shares fell, you would receive £5. So if they fell to 450p you would gain £5 * 50 = £250. However, if they rose to 550p you guaranteed stop loss would be hit and the position closed for a loss of £250.
…and with a CFD?
CFDs work differently, in that you specify the number of CFDs you wish to open the position with. When dealing with company shares, one CFD is equivalent to one share. So, again with company X whose share price is still currently around 500p a share, for your exposure of £2500 you would open your position with 2500 / 5 = 500 CFDs. Why divide by 5? Because the share is trading at 500p, which is £5, and you need to to know how many CFDs you can afford for your desired level of exposure.