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Complete Spread Betting Guide for Beginners
11.How Spread Bets are Priced

To be a successful spread bettor, it’s important to understand exactly how spread betting works. Part of that is understanding how spread bets are priced and spread bet costs.

 

Understanding Spread Bets and the Spread – the Basics

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Spread bets are just what their name implies – bets against a spread. The spread is the difference between the bid price and the offer price quoted for any financial security. All spread betting companies quote a bid-offer spread for all bets.

The bid price is the lower price quoted in the spread – the price at which sell orders are filled. The offer price is the higher price quoted in the spread and the price at which buy orders are filled.

The spread in spread betting is basically the cost of trading, because the spread is where spread betting firms make their money. There are no commission charges for spread betting. The “fee” for trading is instead built into the spreads quoted by a spread betting provider.

The spread betting firm makes its money by quoting a wider spread than the actual bid and offer spread (also known as the bid-ask spread) prevailing in the market for the underlying asset.

 

For example

If a certain stock price has a bid-ask spread of 51 bid at 52 offered, then a spread betting company might offer a spread bet on the stock’s price of 50 bid at 53 offered.

 

How the Spread is Calculated

Most spread betting firms just add a fixed mark-up to the bid-ask spread of the underlying financial asset. The fixed mark-up has been carefully calculated to provide the spread betting company with a net profit on all the spread bets made on a given asset.

As in the example noted above, a spread bet provider may have a fixed mark-up for all spread bets on stocks in the FTSE 100 of one point per side. Therefore, the quoted spread for such stocks will typically have a bid price one pound lower, and an ask price one pound higher, than the respective current bid and ask price quoted on the stock exchange for buying or selling the actual underlying stock.

More thinly traded markets will be reflected by a wider bid and offer spread.

The spreads quoted for any specific spread bet constantly change in accord with the bid and offer spread for the underlying financial security. The spread will be more narrow when betting on securities that are heavily traded, where the trading is very liquid, such as the most popularly traded stocks or currency pairs in the forex market. More thinly traded markets will be reflected by a wider bid and offer spread.

It’s also important to note that spreads quoted vary from one spread betting provider to another. Some spread betting providers typically offer more narrow spreads – spreads more favourable to the spread bettor – across virtually all markets, while some providers may be known for offering better (tighter) spreads for a specific market such as stocks, indices, commodities, or forex.

 

The Time Element

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Time is also a factor in calculating the spread.

For spread bets that are only good for the current trading day, the spread will be the most narrow. Rolling daily spread bets that automatically roll over to the next trading day will have a slightly higher spread that reflects the greater amount of time the bet has to show a profit. The largest bid and offer spreads will be those for futures spread bets that do not expire until a month or two in the future.

The prices quoted for spread bets also reflect interest charges and dividend adjustments, where applicable. There are interest charges on futures spread bets because of the fact that spread betting is a leveraged investment that only requires you to put up a small margin deposit instead of the total value of the financial asset.

Dividend adjustments are made to compensate for stock dividends. With a spread bet on a stock, you don’t actually own the underlying stock shares. Therefore, you don’t receive any dividends that shareholders are paid during the time you hold your spread bet. To make up for this, the spread betting company will reduce the bid-ask price slightly to reflect you not receiving the dividend.

In short, interest charges add to the spread, while dividend adjustments reduce it.

The calculation for a spread on a futures spread bet on a security is as follows:

 

Let's do the math

F = [M+(M x I x E/365)-D] + S

Where,

F = Future spread bet price
M = Current market price
I = Prevailing interest rate
D = Anticipated dividends, if any
E = Number of days remaining to expiration of the futures bet
S = The addition a spread betting company makes to each side of the bid and offer spread

 

Other Costs of Spread Betting

There are other costs that spread betting companies charge in addition to the spread.

1) Interest Charges on Rolling Daily Bets

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While an interest charge is built into the spread for futures spread bets, interest is an extra charge applied to rolling daily bets (also referred to as daily funded bets), based on how many days your spread bet remains open, as the interest charge is applied daily. The interest charge, as in the case of interest applied to futures spread bets, reflects the overnight cost of using leverage whenever you hold a spread bet open overnight.

If you are selling short in your spread bet, you will usually receive, rather than be charged, the overnight interest. However, this is not always the case: in some instances, buyers, those holding long positions, will receive the overnight financing charge and holders of short positions will pay it. On any spread bet you make, your spread betting provider will show whether the overnight interest charge is applied to traders buying long or selling short.

The overnight interest is calculated using a fixed interest rate.

 

Be aware!

The current overnight interest charged by City Index is the LIBOR rate +2.5%. Overnight interest charged on spread bets on currency pairs in the forex market is dependent on the prevailing base interest rate in the countries whose currency is being traded.

Again, overnight interest charges can vary from one spread betting provider to another.

 

2) Special Order Fees

Spread betting firms also charge a small fee for using guaranteed stop loss orders. These are stop loss orders that guarantee an order fill at your specified stop loss price, regardless of the current market price. The fee is only charged if and when your stop loss order is triggered and filled. If your stop loss order is never triggered, then no fee applies for simply placing the order.

3) Futures Spread Bets Rollover Cost

If a spread bet on futures contracts that you have placed is nearing expiration, then you can choose to roll your spread bet over to the next futures expiration period. The rollover cost is half the prevailing spread. This makes rolling your futures bet over half the cost of closing your existing spread bet and opening a new spread bet for the next futures expiration period.

 

Conclusion

To make a profit spread betting, it’s critical to understand how trading costs are built into the spread and how this potentially affects your profit margin on each spread bet. The basic points to keep in mind are as follows:

  • Every spread betting provider offers a wider bid and ask spread than the current market price for the actual underlying asset that you’re placing a bet on. This extra “cushion” added to both the bid and offer sides of the market spread is what enables the spread betting company to make money.
  • The spread offered on any specific financial spread bet can vary significantly from one spread betting firm to another, so it pays to look around for the best (most narrow) available spread.
  • The most widely traded markets offer the most narrow spreads. Thinly traded markets may have extremely wide bid and ask spreads.
  • To win your spread bet, you must overcome the spread. For example, if you buy a spread bet on a stock where the spread is 25-28, then the bid price of the spread must advance to higher than 28 for your spread bet to be profitable.

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