Make tax-free gains from your punt on the markets

Published by Sarah Coles on 11 May 2010.
Last updated on 03 March 2011

investment chart

This year, a combination of two forces is making the use of spread betting and contracts for difference (CFDs) increasinly enticing.

Firstly, markets are set to be more volatile and yet see very little growth, so the fact that both of these instruments enable you to make money from volatility itself makes them particularly appealing.

Secondly, with people earning more than £150,000 a year being hit with a 50% tax on income (from 6 April this year) these tax-free options well worth considering.

What is spread betting?

Spread betting is essentially a form of gambling. Unlike buying shares or stocks, you are betting on which way market or share price values will go.

The 'spread' is the gap between a higher 'buy' price and a lower 'sell' price. You can 'go long' by betting that the market will perform better than the top end of the spread, or you can 'go short' by betting it will do worse than the bottom end.

You don¹t put on a fixed stake. Instead, you bet a specific amount per point.

Say, for example, an index was at 5550, and the spread available was 5545-5555. You may be confident it will rise, so you might put an 'up' bet on, for £10 a point. If it then rose to 5605, you would earn £10 times 50 points, which in this case equals £500.

In effect, the more correct your judgement, the more you'll win. But on the flip side, if the bet goes against you, the more you stand to lose.

Most providers will allow you to set a stop-loss, which means after you hit a particular level of losses, your position will be cashed out, to avoid you running up debts you cannot afford.

What are CFDs?

CFDs work slightly differently. With these, two parties agree to exchange the difference between the current price and a price at some point in the future.

You can be a 'seller', who will make money if the value falls between now and your chosen time in the future. Alternatively, you can be the 'buyer', and benefit if the price rises.

With both spread betting and CFDs, in order to place a bet you have to hand over a deposit of between 5% and 25% (usually 10%) of the underlying value of the deal.

The deposit is based on the margin requirement, which varies according to the asset you're betting on. The bigger the risk, the bigger the margin requirement tends to be.

The ability to bet on margin has the advantage that you don't need all the cash to hand in order to take a big position.

Assuming you wanted to spread bet on the share price of a blue chip with a margin of 10%, you could put down just £100 in order to take a position on £1,000 worth of shares.

The other big attraction is that gains aren't subject to income tax. Phil Seaton, partner of LS Trader, says: "A major factor is the tax-free advantage that is currently in place for financial spread betting in the UK.

"People with higher incomes who have substantial investments will not be too keen to pay the new higher level of income tax at 50%, which came into effect in April this year.

"One way of getting a better return on investments is not to pay any tax on your profits, which can be done in the UK with financial betting."

And because this is classed as gambling, any gains from spread betting are also free from capital gains tax, making them still more attractive. You won¹t have to pay stamp duty with CFDs or spread betting because you don't own anything.
The costs are low too. For CFDs there is a small commission to pay, usually between 0.1% and 0.25%; for spread betting there is normally no commission.

If a position moves against you and you don¹t have enough of a deposit, you will be asked to put up more. You also need to consider the interest on any long position.

Most brokers only charge LIBOR (which is around 0.7% at the moment) plus 2.5%. However, if you leave a position open for a long time ­ waiting for a bet to go in your favour ­ you can find the costs mount up.

The two instruments have much in common, and are both popular with day traders, who can make or lose considerable sums from small price movements. However, they can also be used to protect a position you may have elsewhere.

So, for example, if you had a large holding of a particular share in your portfolio and were worried that the price might fall, you could hedge by going short on the stock, so that any losses on the stockholding would be offset by gains on the spread bet.
These are sophisticated instruments, and can be dangerous for the unwary, so the experts recommend you try a dry run before you take the plunge.

One way to do this is through the dummy accounts offered by some of the providers, which allow you to try your hand at spread betting and get an idea of the potential gains and losses, without the pain of losing your money.

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