With spread betting, you don’t actually buy the underlying asset you want to trade. You just take a view on the prices offered by a spread betting provider, such as Spread Co, as to whether the price will rise or fall. As you don’t have to buy the underlying asset, spread betting providers allow you to trade on “margin.” What this means in practice is that you only have to put up a small percentage of the value of the underlying asset to control a large amount of it. In other words, you are dealing with leverage. As a result, your potential profits are magnified, but so are your losses. For this reason, great care must be exercised in spread betting.
Let’s consider the FTSE100 (the index of the top 100 UK companies by market capitalisation). Spread Co is constantly making a dealing spread, or quote, on the “UK100”, based on the underlying FTSE index. This quote consists of a bid (selling) price and a, slightly higher, offer (buying) price.
The spread between the two can be as narrow as 0.8 points, which means that Spread Co’s charge for opening and closing a spread bet is one of the lowest available. Let’s assume that you get a dealing quote of 6221.1 to 6221.9 – this means that you can “sell” at the lower bid price of 6221.1 or “buy” at the higher offer (or “ask”) price of 6221.9. The difference between the two prices is the spread, which is one of the two charges involved in spread betting (the other charge is called the financing adjustment). The spread is always there, wrapped around the underlying market price. You pay half of the spread when you open the bet and half when you close it.
Let’s say you think the index will rise, so you “buy” £1 per UK100 point at 6221.9 – it’s very important to understand exactly what one point means, as it varies across different financial instruments. As far as the UK100 is concerned, a point is 1.0, so if you buy the UK100 at 6221.9 and subsequently sell it at 6222.9 (in other words when our spread on the UK100 is 6222.9 – 6223.7), that is a full point. Consequently, in this example, for each point the UK100 goes up, you will make £1.