Purchasing shares often seems like the obvious choice when looking to invest in the markets. Whilst shares have their advantages, financial derivatives such as spread bets and contracts for difference could be an interesting alternative or addition to your portfolio.
Financial Spread Betting, What is it?
Spread betting comes down to you predicting the market movement of an instrument. For each point move in your favour, you profit. And for each point move against your position, you incur losses.
You never own the underlying asset, enabling you to bet on both rising and falling share prices. For UK-based traders, this also means you don’t have to pay Stamp Duty or Capital Gains Tax as you would when trading the traditional markets.
The main charge for trading comes from the difference between the buy and sell price (the spread). When you choose a financial spread betting provider, tight spreads mean a lower cost to place your trade.
CFD trading, what is it?
A Contract for Difference (CFD) is a financial derivative where a trader agrees to pay or receive the difference in market price of an instrument from when the trade is opened to when it is closed.
Similarly to spread betting this enables you to profit (or incur losses) whichever way the markets move. CFDs are often used as a way of hedging your portfolio in the traditional markets.
When you place a CFD trade, you will usually be charged a commission by your provider. Besides this you will pay the spread cost on each transaction.
What are the main differences between spread bets and CFD trades?
Tax: CFDs are liable for UK Capital Gains Tax (CGT), whilst financial spread betting normally isn’t. However, this does mean you can offset your losses in CFD trading against your CGT liabilities. (Note: Tax laws are subject to change and depend on individual circumstances, as such we encourage you to seek independent tax advice. If spread betting is your main income you may be liable to pay tax on your earnings.)
Units and Stakes: In CFD trading you buy or sell a certain number of units in the currency of that specific instrument. This means you may lose or gain money due to exchange rate fluctuations. In spread betting you simply place a stake in your currency of choice.
Expiry Dates: CFD positions are not time-limited. Spread bets often have fixed timescales varying between intraday, short, medium and futures trading. In spread betting a provider can close out your position at the end of this timeframe.
Commission: Most of the charge for trading spread bets is included in the spread, though some traders will pay charges such as overnight financing charges. CFD traders are charged a commission in addition to the spread.