Why buy shares when you can spread bet?

The popular image of the active spread better is someone hunched over their screens for umpteen hours a day watching every second-by-second move in a mix of currencies, stock market indices and commodities. But you can of course take a more relaxed and longer-term approach if you want.

Given the interest many spread betters have in individual shares in stock markets, is there any reason why we shouldn’t use spread betting to take positions on shares over weeks and even months? Taking this one step further, why would you buy individual shares when you can spread bet on them?

Spread betting costs versus share dealing costs

Let’s crunch the numbers and see how the costs of spread betting longer term compare with buying shares. Let’s take a fictional, medium-sized company called 'ABC', which is currently trading on the stock market at 299.5p to sell, 300p to buy.

Buying physical shares example

Our investor has around £1500 to invest so she decides to buy 500 shares. This means she has invested £1500 in ABC, but on top of this there are some charges of course. First of all there is commission to pay and this amount can vary from very little to quite a lot depending on your stockbroker and the services offered. Let’s assume a rate of £10 is what our investor’s stockbroker charges for commission on this trade. But we are not done with charges, there is also the government’s slice, or stamp duty, which at the time of writing was 0.5% on shares, so that’s another £7.50 in charges on this transaction. Let’s fast forward a month into the future…

Our investor is delighted that her shares have risen by 10% and so she decides to sell. The market price for ABC is currently 329.5p/330p.  She sells 500 at 329.5p per share, receiving £1647.50. There is usually a charge for selling through your stockbroker so let's assume this is £10 again. Now that our investor has concluded the sale of her shares, let's look at what her total profit is.

To buy the shares, including stamp duty and commission, she had to spend £1,517.50. When selling, after paying commission again on the sale, she received £1637.50, so the profit on this deal was £120 – an excellent return after just one month, but was there a more cost-effective way of doing this?

Spread betting example

Now let’s look at taking on a similar position via a spread bet. The spread betting price quote on ABC is slightly wider than the market, so we will use 298.5p to sell, 301p to buy. To have the same exposure as buying 500 shares our investor needs to buy £5 per point. If you look at the maths here it makes perfect sense: £5 x 301= £1505. So the position value of the shares using a spread bet is equivalent to £1505 worth of shares. If the value of the shares increases or decreases then the spread bet will follow suit.

There's no commission or stamp duty to pay and in addition, because spread bets trade on margin, our investor does not need to tie up all her capital. It is important to remember, however, that the loss you could make on a bet may exceed the amount of margin that you used to enter into that bet. This is a feature of leverage (margin trading) and it means that your losses are magnified and you can lose more than your deposit. Let’s assume the margin deposit for this particular share is 10% of the value of the position. This means that, in this case, £150.50 would be allocated from her spread betting account to open a spread bet worth £1505 on company ABC.

Once again, we use our time machine to jump forward a month and the share price has risen 10% so the price of the spread bet instrument is now 328.5/331. Our investor decides to take her profits, closing the spread bet by selling at 328.5. Her profit in points is 328.5 – 301 = 27.5, and of course her stake was £5 per point which nets her a profit of £5 x 27.5 = £137.50.

There would of course have been some charges incurred along the way as well with this spread bet. Because she is trading on margin she is effectively 'borrowing' money from the spread bet provider, so there is a daily financing charge applied to her spread bet. This rate is usually based on Libor (London Interbank Offered Rate) plus a percentage, which will vary from broker to broker. Let’s assume our investor’s broker charges Libor + 2.5% and Libor is currently 0.45%.  This means her financing will cost 2.95% if held for a year, but this is broken down to a daily rate so the daily cost for this spread bet is around 0.0081%. On a position value of £1505, that equates to about 12p per day. Over the month that would mean financing charges of around £3.65 would have been deducted from our investor's account, leaving her with an overall profit of £133.85. That’s still more than she would have made buying the shares through a traditional stockbroker, plus our investor did not have all of her £1500 tied up in the shares – she had ample funds left over to take advantage of other opportunities if she wanted to.

What about long-term share positions?

Now, it won’t always be more competitive to trade on shares using spread bets. If you were going to hold for many months, or even years, of course the cost of those financing charges would outweigh any savings in stamp duty or commissions. But for short- to medium-term trades, spread betting on shares can be a viable and much more cost-effective option than buying through more traditional means. 

Disclaimer

CMC Markets does not endorse or offer opinion on the trading strategies used by the author. Their trading strategies do not guarantee any return and CMC Markets shall not be held responsible for any loss that you may incur, either directly or indirectly, arising from any investment based on any information contained herein.

CMC Markets is an execution only service provider. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.

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