How Spread Betting and CFD Trading Work

Contracts for difference (or CFDs) are short-term leveraged derivative contracts that track the value of an underlying instrument. Spread betting, on the other hand, involves placing a speculative bet on the price movements of an underlying instrument without owning the asset.

Although both CFDs and spread betting are very similar in that they’re both leveraged products, allowing traders to open relatively large positions with just a small percentage of the trade’s full value, there are several differences between them.

What are CFDs?

Contracts for difference, or CFDs, are derivatives that allow traders to speculate on both prices going up dan down on underlying financial instruments.

A CFD is a contract between two parties:

• the trader (buyer of the contract) and the broker (seller of the contract). It states that the seller will settle with the buyer based on the difference between the current price of the underlying asset (shares, currencies, commodities, indices, etc.)
• its price at the time the contract is closed. If this difference is positive, the seller pays the buyer; if negative, the buyer pays the seller.

CFDs do not involve ownership of physical goods or securities. Instead, a CFD represents a tradable security established between a client and a broker who are exchanging the difference in the initial price.

What is spread betting?

Spread trading (also known as financial spread betting or FSB) allows investors to speculate on the price movement of a wide range of financial instruments (such as shares, indices, currency pairs or commodities).

Basically, investors make a bet based on whether the price of the market is likely to go rise or fall from the time their bet is accepted.

Investors are also able to choose the amount they want to risk on their bet. Spread betting is a tax-free, commission-free activity that allows investors to speculate in both bull and bear markets. The bet cannot be transferred to anybody else.

Spread-betting companies offer buy and sell prices to potential investors, allowing them to place investments based on their market prediction. Investors use the buy price if they expect the market will rise, or the sell price if they expect it to fall.

Unlike traditional investing, spread betting is a form of betting. However, unlike fixed-odds betting, it does not depend on a specific event happening.

You can close the bet at any time to secure profits or limit losses. Financial Spread Betting (FSB) is a margined derivative product that allows you to bet on the price movements of various financial markets and products, including stocks, bonds, indeks, currencies, etc. Investors can take into long or short positions based on their predictions of market direction.

Similarities of CFDs and spread betting

Leveraged products

CDFs and spread bets are leveraged products that derive their value from an underlying asset. In these trades, the investor does not own the underlying assets. When trading contracts for difference, you are speculation on whether the value of an underlying asset will rise or fall in the future.

Going long and short

CFD providers offer contracts that allow for both long and short positions based on the prices of the underlying assets. You take a long position when you expect the price to increase, while you short sell when you expect the price to fall in value. In both scenarios, you are aiming to gain the difference between the closing value and the opening value.

Similarly, a spread is defined as the difference between the buy price and the sell price quoted by the spread betting company. The underlying movement of the asset is measured in basis points, allowing you to buy long or short positions.

Margin and mitigating risks

In both CFD trading and spread betting, an initial margin is required as a preliminary deposit. The margin typically ranges from 5% to 20% of the value of the open positions. More volatile assets generally require higher margin rates, while less risky assets require lower margin.

Even though both CFD trading and spread betting investors contribute only a small percentage of the asset’s value, they are entitled to the same gains or losses as if they paid 100% of the value. However, in both investment strategies, CFD providers or spread betting companies may require the investor to make a second margin payment at a later date.

You can never completely avoid risk when investing, but it’s your responsibility to make strategic decisions to minimise serious losses. In both CFD trading and spread betting, potential profits can be equivalent to 100% of the underlying market’s movements, but potential losses can also reach the same extent.

In both CFDs and spread bets, you can set a stop-loss order before entering into a contract. A stop loss is a predetermined price level that automatically triggers the closure of the contract when the price is reached. To guarantee stop-loss orders are executed, certain CFD providers and spread betting companies offer guaranteed stop-loss orders at a premium price.

Key differences between CFDs and spread betting

Fixed expiration dates

Spread bets have fixed expiration dates determined at the time the bet is placed, whereas CFD contracts do not have fixed expiration dates. Additionally, spread betting transactions take place over the counter (OTC) through a broker, whereas CFD trades can be executed directly within the market. Direct market access in CFD trading bypasses certain market pitfalls by allowing for transparency and simplicity in executing electronic trades.

Commissions and fees

In addition to margins, in CFD trading the trader pays commission charges and transaction fees to the provider. Spread betting companies do not charge fees or commissions. When the contract is closed and profits or losses are realised, the investor either receives money owed or owes money to the broker.

If profits are realised in CFD trading, the trader will calculate the net profit of the closing position by subtracting the opening position and any applicable fees. In spread betting, profits are determined by multiplying the change in basis points by the dollar amount agreed upon in the initial bet.

Dividends

In both CFD trading and spread betting investors holding long positions may receive dividends from the underlying asset. While they do not own the asset directly, both CFD providers and spread betting companies pass on dividends to investors when the underlying asset performs well. However, profits from CFD trades are subject to capital gains tax, while profits from spread betting are tax-free.

In summary

Spread betting and CFDs are both leveraged investment products that share similar fundamentals, which may not be immediately obvious to new investors.

Spread betting is conducted over-the-counter, normally without commission fees, and profits are often not subject to capital gains tax. On the other hand, losses in CFD trading can sometimes be tax deductible, and CFDs offer the advantage of direct market access.

Both strategi carry real risks, and the decision on which investment to choose to maximise returns is entirely up to the educated investor. It’s important to note that both CFDs and spread betting are legal only in some countries. CFDs and spread betting are both illegal in the United States.

Disclaimer:
This information is not considered investment advice or an investment recommendation, but instead a marketing communication. IronFX is not responsible for any data or information provided by third parties referenced or hyperlinked in this communication.