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How do spread betting companies make money?
There was an article this morning entitled “Everything you need to know about spread-betting charges” that contained zero helpful information about spread betting charges.
So, here we’ll take a quick look at how spread betting companies make money and also how they charge their clients.
There were lots of quotes from brokers which looked like they came off a press packed special provided by a PR company. What the article failed to do was explain whey spread betting companies charge overnight financing fees.
Firstly, lets clear up how spread betting brokers make their money – there are three ways:
- The spread
- Overnight financing
- Position netting (the b book)
Spread betting companies historically made their money by widening the spread of an instrument such as the FTSE. Say the FTSE was trading 5550 bid 5551 offered they would quote 5545 bid and 5555 offered. Yes amazingly they were able to quote a ten point spread in the FTSE so if someone was betting £10 per point their profit was £90. However, due to competition spread are now pretty much inline with the market prices on popular markets. For liquid markets they can be quite wide, but they are still very competitive. Obviously spread betting companies have had to look else where for their profits.
This is what the broker charges you for running your position overnight. As spread betting is a leveraged product you only have to put down a small deposit to have a lot of exposure. For example you can buy £10k worth of Vodafone with only £500 down as a deposit. So essentially the broker is lending you £9,500 for the trade. There is a cost to this and it is either small or large depending on your perspective.
If you are the type of person who thinks everything on the internet should be free you will think it is outrageous that they levy this charge on traders. If you are sensible you will realise that it is in fact a very cost effective way of trading above your means. You alternative you are borrowing money from banks credit cards or using cash money that you would have otherwise paid off these debts with to be unleveraged in trading and speculation.
What is amazing about the financing rates is that they have been pretty consistent since the industry started. they are still around 2.5% – 3% over/under LIBOR or 1 month LIBOR. With LIBOR being so low it means you are charged 2.5% – 3% on longs. You are also charge don short because the rate inverts to a minus figure. If LIBOR was above 3.5% you would receive.
Often referred to the B Book. This simply means that it is not cost effective to hedge every single small trade that is executed online. Stock exchanges charge for every transaction that is made. In some cases spread betting companies will also let clients trade in stake sizes smaller than the underlying market.
For instance, the FTSE 100 future trades in 1 lots. The size of this 1 lot is equivalent to £10 per point. If the FTSE is trading at 5550 then the value of 1 contract is £55,500. So the options for customer are either trade in big size or let the spread betting firms net off your trades against other clients or simply hedge when exposure gets to a certain point. most brokers are very risk averse now so will only take a limited amount of risk on their clients losing money – even though most do (eventually).
Is overnight financing a bad thing?
No it is not. You can either borrow money to trade from your bank or your broker. It is cheaper to borrow it from your broker. Also, if spread betting firms lost this particular revenue stream then spread would have to be wider. Or worse still, as the market become more competitive, everyone would go out of business. That may be good for consolidation, but competition in the industry is what makes British trading platform some of the most intuitive and datacentric in the world.
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