Spread bets and CFDs are leveraged and very high-risk investment products. Using leverage can potentially generate substantial profits from relatively small investments. This means they carry a far higher level of risk than traditional investments and customers can lose more than their initial investment, and end up owing money to the business. They are typically used to make short-term bets or trades based on whether you think the price of a particular underlying asset is going to go up or down. The key difference between spread betting and CFD trading is how they are treated for tax purposes. Underlying markets offered include foreign exchange, equities, indices and commodities.
Spread bets and CFDs are only right for you if:
These are very high-risk products. If you don’t understand a financial product get independent financial advice from a regulated financial adviser before you invest.
- You understand that these products are traded on margin. That is, they do not require you to put up the full value of the underlying exposure you take.
- You appreciate that the leverage which margin trading affords significantly magnifies your risk to both positive and negative price movements.
- You realise that your trading costs will be based on the full value of your investment exposure. Extra charges might apply if you hold a position open over a period of time.
- You’re aware that the leverage inherent in the products means you could lose much more than your initial outlay. You could end up owing additional monies in excess of your deposited funds.
- You can afford to lose your initial outlay and potentially more.
- You’re not looking for a long-term investment. You have the time to monitor your investment carefully so you can respond to market changes.
What are spread bets and CFDs?
Spread bets and contracts for differences allow investors to gain exposure to the price movement of a wide range of underlying assets without actually owning the asset or putting up the full value of the asset you’re exposed to.
They are typically not sold on regulated trading venues. Instead, you are typically trading directly with the firm (commonly known as over-the-counter) and on non-standardised terms.
Financial spread betting operates in a similar manner to a CFD except that you bet £x per point on the assets price movement (either up or down) and then pay or receive the difference between the opening and closing price of the bet. Spread bets are tax-free in the UK and Northern Ireland - under current legislation. CFD is not tax-free in the UK.
Did you know?
The FCA analysed a sample of client accounts from UK CFD firms and found that 82% of clients lose money and that, on average, clients experienced a loss of £2,200 when trading these products.
Because you don’t own the actual underlying asset, spread bets and CFDs are classified as financial derivatives.
The fact that they also do not require you to fund the full value of your underlying exposure means that they’re considered complex products.
To place a bet or make a contract, you only need to hand over a deposit, a small percentage of the full investment.
This means you have the chance to make profits with only a small outlay, but you can also lose a lot of money fast – and even end up in the red – if prices move in the wrong direction.
What’s the difference between spread betting and contracts for difference?
CFDs and spread bets are both leveraged derivatives that enable clients to have exposure to changes in an asset’s price, without owning the asset itself. An opening CFD / spread bet contract is established by initiating a buy or sell position in the required amount. This is subsequently reversed to close the contract, which is then cash settled.
The primary difference between these products is how they are treated for tax purposes:
- If you make money on CFDs, you will have to pay Capital Gains Tax (CGT) if you go over your CGT threshold for the year. You don’t have to pay Stamp Duty when you buy or sell contracts for difference.
- You don’t currently have to pay CGT on spread betting winnings because it is considered a form of gambling. Although you could be liable to Income Tax if your spread betting is deemed to be a trade, that is if you’re living off the profits made.
Should you consider spread bets or CFDs?
CFDs and spread bets are complex, leveraged derivative financial instruments. They are high-risk products that are unlikely to be appropriate for most retail investors. Retail investors are at risk of losing more than their deposited funds.
Only consider investing in these complex, high-risk investment products if you can answer ‘yes’ to all these questions:
- Do you fully understand how they work?
- Do you understand how you can make and lose money using these derivative products?
- Do you understand how the leverage these products offer magnifies your exposure to relatively small price movements in the underlying market?
- Do you understand the terms and conditions of trading with a prospective provider? Such as how and when they might require you to provide additional funds to cover your investment? And in what circumstances they might close-out your trades automatically if you’re losing money on a position?
- Do you have enough money that you can afford to lose your entire investment and possibly end up owing even more?
- Do you realise that if you lose you not only lose your initial investment, but you might need to pay out additional money as well?
- Do you understand that how much extra above your initial investment you might have to pay if you lose is driven by your exposure to leverage?
- If things do go against you, will you have enough money to pay additional losses over and above the funds you initially allocated to this investment?
- Do you realise these products are designed for short-term, speculative investment and require careful monitoring? They are generally not appropriate for meeting longer-term investment objectives?
- Do you realise that using training tools and trading accounts when no real funds are at stake, will not fully replicate your trading behaviour and attitude to risk when using your own money?
- Do you know that the firm offering these investments is authorised and regulated by the FCA?
Binary options and spread betting
Binary options and spread bets are very similar in that they both allow traders to predict the price movements of a wide variety of underlying assets and risk money on those predictions. They are effectively gambling products dressed up as financial instruments.
As such they are considered high-risk products that are unlikely to be appropriate for most retail investors.
Since 2 April 2019, there has been a permanent ban on the sale of binary options to retail consumers. This is due to widespread concerns about the inherent risks of these products, and the poor conduct of the firms selling them.
The sale, marketing and distribution of contracts for difference (CFDs) and similar products to retail customers has also been banned by the Financial Conduct Authority (FCA).
If things go wrong
Spread bets and CFDs are specified investments, which means firms that deal, arrange, or advise on them are required to be authorised and regulated by the Financial Conduct Authority.
If you’re unhappy with the service you get or you want to make a complaint, read Sort out a money problem, make a complaint or get compensation.
Remember, however, that you cannot claim compensation if you lose money on a bet.
Do your homework so you won’t be tempted by companies marketing these products without giving you all the facts.
Don’t be attracted by claims of potential profits or ‘free’ trading credit. These are high-risk investments, and you might end up losing money.
Make sure you fully understand the features and risks involved in these complex derivative products.
Stay away if you have any doubts or do not understand them.
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