Spread betting needn’t just be about betting whether something goes up or down. Once you’re comfortable with how everything works, you can also use it in more advanced ways too – perhaps to support other investment descisions. Let’s take a look.
The definition of hedging is making an equal investment in a holding you own that limits potential losses, (protecting it); in case it drops in value. This lets you leave your share protected in the event of a price drop.
Spread Hedging is used to protect a physical share portfolio against short term market drops. A spread bet avoids stamp duty and brokerage charges, whereas hedging incurs theses charges. Hence, in a cheaper way you are able to make a wise investment for yourself.
Peter owns mostly FTSE 100 shares with a combined value of £40,740. He has reason to think that the FTSE 100 is going to drop. He could sell his shares, wait for the market to drop, and then buy them back. The problem is, Peter has huge gains on his portfolio, and if he were to sell, he would have to pay high capital gains taxes.
One thing that he can do is to hedge his portfolio by selling the FTSE 100 short. If the FTSE does expectedly fall, any value drop in his portfolio will be offset by money he makes by going short.
Let’s say Peter takes the spread betting route: He sells £10 per point of the FTSE 100 futures at 4,074 points, and the quote is 4,074- 4,080.
Scenario 1 – The FTSE drops 10% to 3,666. If Peter’s shares dropped at the same %, his portfolio would drop to £36,666.
If Peter chooses to buy the FTSE 100 future at 3,666 his gain would be GPB 4,080. (4,074-3,666) times (£10). In other words, his losses would be the same as his short position.
Scenario 2 – The FTSE stays at 4,074. If Peter’s shares reflect the index, his portfolio would stay the same at £40,740.
When Peter decides to put back the FTSE 100 Future by closing his short position, his loss of the spread will be 6 points times £10 = £60.
Scenario 3 – He is wrong and the FTSE rises to 4,150. His portfolio will go up in relation to £41,500. His losses will be basically the same.
There are many points to note about this hedge:
- His overall position was mostly not affected since he set it up as a counterweight to his share portfolio. The hedge kept him in market neutral position.
- He can take safeguards against a market fall without selling his shares or paying capital gains taxes.
- Even when he was wrong about the FTSE, with the hedge in place, he only lost GBP 60, a price he was willing to pay for peace of mind.
- You can hedge your portfolio by placing an equal short spread bet in a similar market.
Momentum trading works like an object rolling down a steep incline, and gaining speed as it goes. There is always a movement in the market and we should keep our senses open to make profit from this market movement.
In the share market, a buyer will buy or sell when there seems to be more activity. Other traders follow example, and it then becomes a feeding frenzy. In order to understand momentum trading, you must find out the actual amounts of what others are buying and selling. This is known as trading volume. Traders can find this out through Level II data, which is all the information available from the stock exchange. Usually, only private investors can afford Level II services.
An example of this is: A company ‘Shoed In’ is in the market at 304p – 338p. In the next two hours, almost all volume is changing hands at 338p. To a momentum trader, this is a strong signal to buy. The idea is that since most trades are buy trades, the share is on the way up.
Momentum is about whether the stock market is bearish or bullish.
When you go long on one share and go short on another in the same sector is known as pairs or hedge trading. When you put a long bet on one share, and an opposite short bet on another related share, all you are doing is wagering on the differences between the two securities, instead of the way the overall market is going. The thought is that if both shares are in the same sector, they will both rise or fall. Although if one company is stronger than the other, the stronger company, of course, with get a higher price rise.
We will use the cable television market and assume that we’re bullish about its prospects. If we choose two different companies, Cable XYZ and Cable ABC; if Cable XYZ has profits that have not been on the rise for the last three years, and Cable ABC posted a profit warning only two months ago, then it is safe to assume that company XYZ is the stronger company.
The definition of pairs trading is: selling securities that you do not actually own, so that you can buy them back in the future for a lower price and make money.
Tom places an up bet on Phone Co. XYZ and a down bet on Phone Co. ABC.
Scenario 1: The phone sector gets a re-rating. Both shares go up. Share in Phone Co. XYZ goes up 10% and Phone Co. ABC goes up 3%. The gain from XYZ makes up for the losses in ABC.
Scenario 2: The phone sector has a re-rating. Both shares go up. Phone Co. XYZ and Pone Co. ABC both go up by 10%. They break even as a result.
Scenario 3: The phone sector has a de-rating. Both shares go down. Shares in XYZ fall by 10% while those in ABC fall 15%. Money made from the down bet on ABC makes up for the loss on up bet of XYZ.
Joseph thinks that in December 2003 that Verizon was overpriced in its sector. He decides to place a sell bet in Verizon to buy in Sprint, in the hopes that Sprint will go up and Verizon will fall. When he placed a pairs trade, he was protected from overall market risk. If the sector was to fall, he would make profits on Verizon and lose on Sprint.
Result: The pairs trading was a big success: Verizon fell from 1,700 to 1,420, and Sprint gained from 1,300 to 1,730 over a year’s time.
Pairs trading can also be done on two companies from different sectors. There is no criteria that enforces betting for one sectors and hinders the other. One can be a utility sector and one can be a telecommunications company. The goal in pairs trading is for one share to outperform the other. Hence, leading to your profits.