Hedging using spread bets

By Deputy Editor Tim Bennett Jan 13, 2010

Many investors associate spread betting with gambling on rising or falling prices to make a fast buck. However there is a safer use for them – as protection for a portfolio.

For example, say you hold £100,000 of FTSE 100 shares and are worried that prices may dip sharply over the next three months. You could sell the lot, wait for prices to fall and then buy them back cheaper. The trouble is this route will incur several costs.

These include stamp duty of 0.5% when you buy back your shares, and two sets of dealing commission. Worse, if you sell the shares at a profit you may incur a capital gains tax charge. And what if you are wrong about prices falling? Having dumped your shares, you would be forced to buy them back at a higher price later.

Enter hedging. You could hang onto your shares instead and place a down bet on the FTSE 100 using a spread bet.

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For example, say the FTSE 100 spread is quoted at 4,999-5501 when the index is at 5,000. You place a down bet at £20 per point (£100,000/5,000) and sell the index at the “bid” of 4,999. The index subsequently drops 5% to 4,750. So your shares are down around £5,000.

However let’s say the new spread quoted by your broker is 4,749-4,751. If you close the spread bet, by buying it at 4,751, your profit is 248 points (4,999-4,751). At £20 per point, that’s a tax-free cash gain paid by your spread-betting broker to you of £4,960.

Sure, that’s not quite enough to cover your £5,000 loss on your shares – because you lose the “spread” to your broker – however it’s pretty close. You could now reinvest that £4,960 gain in new shares to bring your portfolio back up close to its original £100,000 value.

Published in Spread betting | More articles by Tim Bennett

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