In practice, spread bets and contracts for difference are quite similar in terms of types of risks taken and type of bet; both offer traders and investors the capacity to utilise leverage on their investment. Both allow traders to take a long or short position on the movement of the price of a financial asset; including individual shares, indices, commodities and foreign exchange as opposed to buying the asset directly.
In a conventional stock purchase, an investor may pay for instance, £5,000 for 1000 shares, or £5 per share. If those shares rose by £2 each to £7, the holding is worth £7,000 – a nice 40% profit. With financial spread betting, you can bet on the movement of stock prices, and you get a lot more exposure for much less capital outlay. So for instance, if you place a spreadbet for £50 per pound increase on a £5 share, you are getting the same exposure as the £5,000 shareholding (to get an idea of your total exposure for UK shares always add two zeros to the amount you have bet per point), however to place this bet the spread betting provider might only ask you for an initial margin of £500. And of course you can also speculate that the shares will fall.
The way spread bets and CFDs are also quoted differently – spread betting providers usually quote a bid and offer price that speculators have to take. Quote-driven (i.e. market maker) CFD providers also quote prices in this way, but DMA providers may allow you to post your own prices within the bid-offer spread which means that you become a price maker.
With spread bets, you don’t have to pay any commission to your provider, although you do with CFDs. CFD providers and spread betting companies make their money from dealing spreads and interest charges. CFD providers also charge commission on share trades, but generally not on transactions involving other assets.
From an investment perspective, any profits made on a contract for difference will be subject to CGT (Capital Gains Tax) if an investor’s income exceeds the 10,000 personal allowance. Any profits made from spread betting will not be subject to CGT. Neither CFDs or spread bets are required to pay stamp duty saving 0.5% compared to share trades. CFDs are traded in a similar style to shares trading as all trades are based on the number of shares an investor wishes to deal in. Spread bets are based around how many pounds per point the client wants to bet on.
With both contracts for difference and spread bets, speculators can make money if they are correct about movements in a stock price, commodity or index. Both present prices as “bid” and “offer” and allow investors to go long or short, letting them make money from rising or falling markets.
One other difference to note is that while spread betting gains are monetised in the investor’s base currency, CFD trades are denominated in the base currency of the underlying market and are thus subject to currency fluctuations. To get this into perspective if you are making $1000 in a trade on Apple, but the sterling rallies 6% against the USA dollar, then your net gain when you transfer your winnings back into sterling would be worth less than when you initiated the trade.
There are also some differences in how margin costs are imputed and there are also important differences in contract expiration or lack of them – but in actual fact spread bets and CFDs are more similar than different. Choosing between the two investments can be a matter of personal preference although in reality nothing stops you from opening an account that allows you to trade both CFDs and spread bets.
Although spread bets and CFDs are quite similar products, they differ in one crucial respect. Profits on spread bets are tax-free whereas CFD profits are taxable. The reason for this is that spread bets are classed as wagers, whereas CFDs are investments.