CFDs vs Spread Betting

CFDs (Contracts for Difference) are very similar to spread betting contracts’ pricing structure but not indetical, the important differences are that CFDs have no expiry date, they are subject to capital gains tax and are subject to overnight interest policy.  Spread betting on the other hand offers contracts that have expiry date, is not subject to capital gains tax, and not subject to overnight interest, at least not in the same way as CFDs.

When you trade CFDs on shares of a stock you actually determine the number of shares to trade on, but you are only betting on the movement of the price of those shares, not actually buying them, this transaction differs from classical share dealing in one more way in that there’s no stamp duty, in this regard it is more attractive choice to short term traders. To longer term traders seeking to hedge a long portfolio or make an intentional apparent loss on their account, for tax reduction purposes, while hedging this trade, they can hedge the losing trade tax free using a separate spread betting account!   In this situation the trader needs both CFDs and spread betting.

In other scenarios, such as medium to long term trading CFDs are better than spread betting if price linearity is required, this means if the underlying stock rises by ₤10 within an expected quick 2 week period or less, the quarterly spread betting contracts may not reflect the full gain, especially if the contract has long time left till expiration, it may only reflect a ₤8 gain, whereas with a CFD contract you can gain the entire ₤10 price movement on the stock, and since it’s only 2 weeks, it may be worth paying the overnight interest. It all comes down to linearity, duration of the trade, tax considerations and spread commission costs, in some cases CFDs will be better. Spread betting contracts tend to mature near expiry date, that’s when the open spread bet contract in our example will reflect the exact gain of the stock, at that time, but what if the stock has droped by that time, it’s certainly something you want to consider carefully depending on the duration and magnitude of the expected stock price move, this is what determines whether CFDs or spread betting will be better to use!

In cases where the entire taxable gains on a CFD account need to be reduced, one can execute a fully hedged, carefully planned hybrid trade involving both CFDs and spread bet contracts. Just by making a loss on the CFD account, while hedging the trade in a separate spread betting account, it could help reduce your capital gains tax liability.

Overnight interest is a little bit of an issue, generally we face the same problem in ECN forex accounts,  and we have to pay interest on long positions, and get paid interest on short positions, depending on the interest rate differentials. Interest is a minor issue, most of the time you will notice that CFDs being a highly leveraged instruments,  whether your open trade is in profit or loss depends a great deal on the price movement of the underlying stock or commodity.  Most of the time, 95% of the amount of the open profit or loss is actual profit or loss of the trade which depends on market direction and whether you predicted it right, the remaining 5%  will be the interest credit or charge. As long as you plan your trades right and manage to overall win, interest charges will not be an issue at all, they can only be an issue if you buy CFDs to go long on a stock with the desire to hold it for many many months or years, it’s the same thing as buying shares on margin, where you would also have to pay daily interest, but in this kind of very long term holding you might want to consider a series of spread betting positions instead.

Please note that it is statistically proven that 70% of the time, stock go nowhere, neither up or down, holding long onto a stock portfolio is not actually a very wise idea, despite the fact that annualised returned are often claimed to be high, as high as 12% or even 20%, the actual cost of inflation is around 6% – 7% a year and never mentioned  it or price it in these claims!  It is not wise to hold onto a stock indefinitely, even stocks with proven records and excellent balance sheets, you would be much better off investing in these stocks once or twice a year, as soon as they drop from recent highs.

Generally speaking, both CFDs and spread betting contracts are equally useful, and they tend to suit different trading needs in the markets, no trading instrument is really redundant, each one offers unique characteristics.  The key problem with spread betting is temporary absence of linearity from time to time which results in an inability to capture the entire market move (whether profitable or not), the fact that spread betting contracts expire is not really a problem, it only means that the linearity is in place as the contract nears expiration, so that the open spread bet trade fully reflects, pound for pound the underlying profit or loss. CFDs can be better in that regard but profits realised are subject to capital gains tax, so this is an equally important factor.