Trading on the margin

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Spread betting firms have marketed their services as a one-stop shop for a range of markets. The point is often missed that if you have a spread betting account, you are trading futures by one step removed.

Spread betting firms use the futures market to lay off the liability that their clients' activities generate. Consequently their spreads almost always track futures prices closely. The exceptions to this rule are the 'daily cash' bets on index movements.

The parallels with futures extend to the question of margin. Futures are traded on margin. This is a small initial deposit that enables an investor to buy a futures contract with a low down payment, but which consequently magnifies the potential risk and return. The same thing happens in spread betting. Spread betting firms usually call it something other than margin, but the principle is the same.

When you open an account with a spread betting firm you have to deposit cash before you can begin trading. For each deal you undertake, a margin figure is calculated based on the size of your stake multiplied by a bet-size factor, which differs from instrument to instrument.

Notional trading requirement

The result is called the notional trading requirement (NTR). This is margin by another name. You must have at least this amount on deposit in your account before you trade. If the trade goes wrong, you will be asked to top up your account immediately to offset any losses.

For example the bet-size factor for the FTSE 100 index might be £250. If you bet in £10 a point, you must have at least £2,500 in your account to fund the trade at the outset. In reality, you will probably need more than this to avoid constant margin calls in the course of the normal up and down movements in the index. Looked at another way, if you have £2,500 in your account and bet in £5 a point, the initial NTR is £1,250. If the index were to fall 50 points at the outset, your initial £250 loss would be called out of your account to restore the correct NTR figure.

Bet-size factors are determined by the volatility of the underlying product you are trading. The less volatile the instrument, the lower will be the bet-size factor and the low the effective margin. The bet-size factor in the Nikkei 225, for example is 500, while for gold is 150.

It's important to remember that while indices like the FTSE 100 (UKX), the Nikkei and the Dow are traded - in spread betting terms - in a unit that corresponds to an index point, some other spread bets are not. This so-called 'tick size' in gold, for example, is $0.10. The bet-size factor for gold is 150. So bet in £10 a point on gold, for example, and although the NTR or margin would be only £1,500, in reality you are actually staking £100 on each $1 movement in the price.

Spread bet in shares, as many punters do, and the NTR is a simple 10% of the underlying value. So spread bet on Vodafone (VOD) at, say, 150p at £10 a point, and the NTR would be 10% of £1,500, or £150.

The bottom line is that NTR acts as a cash cushion. In theory, it should prevent you from getting in too deep.

Placing a bet

There are a few rules you need to observe beforehand.

For a start, be aware of the bet-size factor before you place a bet. Don't place a bet that could result in being asked for further cash if only a small movement occurs in the underlying price. Dealing with margin calls is frustrating and time consuming for all concerned.

Remember too that the margin percentage required is also probably going to be bigger than it would be if you were trading the equivalent future. Spread betting firms are not charities, and there is no percentage in them simply flowing through the underlying margin payment to their clients without taking a turn in the process, if only to offset potential bad debts and administration charges.

The other point is that because the system encourages you to keep your account fully funded, you will often have more cash sitting in your account than you require, giving the bookmaker the benefit of earning interest. Some bookmakers offer interest on credit balances, but you need to check on this before you open an account.

Peter says

I have always found spread betting to be a zero-sum game. I have had winners and I have had losers. Yet there are those who make money consistently out of trading this way, the point being that geared up short-term trading is an occupation to which you are either temperamentally suited or not. Clearly, I am not suited to it.

Being cautious by nature and wanting to avoid margin calls, when spread betting I have always tended to have more capital tied up in my account than is strictly necessary. In the end I concluded that, for me, a game like this was not worth the effort.