Over the last 6 months, many of my friends have been asking me “What is spread betting or spread trading?”. Many of them were surprised to learn exactly what it is. The example I used to explain what this form of trading is was comparing spread trading to buying shares through a stockbroker. As many of my friends work in financial services sector and are all involved with company share saver schemes or company share options schemes, they were interested in what sort of benefits spread trading has over the traditional model of buying shares through a stockbroker.

It’s funny, but since I’ve started trading with paddypowertrader, I stumbled across their spread betting versus stockbroker page, so I thought it appropriate that I use that to explain.

I suggest you have a play around with the different options and see how you get on and to see how the different trades work out. I think that it shows the difference between the costs associated with a stockbroker and those associated with a spread bet. It also shows how the margining or leveraging of spreadbetting works to help you keep more money in the bank if you were to spread trade rather than buy your shares through a broker.

The obvious main advantages spread trading has over share trading is obviously that you can go long or go short, as well as the fact that you don’t currently have to pay stamp duty or capital gains tax on the profits from your trading. Interestingly, there are a few other things that you can do with spread trading that you can not easily do with a stockbroker as a conventional retail customer, and over the next few months, I will go through some of the different things that you can do with a spread bet that you might not have realised before.

Short Trade As Share Insurance, Hedging Shares
One thing that spread trading allows is the ability to hedge any shares you hold. If you have stock options, share options or share scheme bonuses accumulating over time in your company and can’t sell them for tax reasons (or any other reason), a short spread trade enables you to fix the value of your holdings. By shorting an equivalent holding in an share that you own as a result of a share scheme in your job, you are effectively locking in the value of your holding. With the way the margin/leverage works out you don’t need to put down much money up front to achieve this “share insurance”.

So imagine you have just got a bonus of say 10,000 shares. If you are happy with this now but want a method of fixing or guaranteeing the share price, you can do this with a spread trade. If you place a short trade of the equivalent size, in this case £/$100 a point (number of shares / 100, i.e. 10,000/100 = 100), if the price of the share goes down your short position will be in profit and so at the end of your minimum holding period you will be able to close out the spread trade at a profit and sell the shares at whatever price they get and you end up with the amount you had at the start. Hence, you have locked in your current share bonus.

On the other hand, if the price of the shares go up, your short spread bet will not be in profit but your shares will be, so at the end of the holding period, you close the spread trade and sell the shares. Again, you end up with what you started out with. In this example you have lost out on the upside of the price gain, but for those that are more risk averse and in current financial market conditions, assuming a share price will go up is pretty bullish. I think that having the guaranteed fixing of the value is better – at least I can budget for it in the future rather than hoping for it.

This example obviously doesn’t take spread or rolling charges into account for the purposes of the calculations but those costs are quite small compared to the overall size of the trade or the portfolio.

So, in this example, the spread bet has limited your upside and downside. I used to work for a bank and did a trade along these lines at the beginning of January 2008 and closed it out in November 2008. It saved me quite a bit of money over the time the trade was open and at the end I still have the shares which I will no doubt pass on to my grandchildren to see if they can recoup some of the value of them!

Anyway back to trading Wall St for me.

Hope some of you found this useful.