Spread bets and contracts for difference (CFDs)
Spread bets and CFDs are leveraged products. 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. Underlying markets offered include foreign exchange, equities, indices and commodities.
Spread bets and CFDs are only right for you if:
These are high risk products. If you don’t understand a financial product get independent financial advice 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?
Did you know?
A study by the Cass Business School reported that only one in five people who invest in financial spread bets and CFDs end up a winner.
These products let you make a cash settled bet or contract on the price movement of an asset without actually owning or putting up the full value of the asset you’re exposed to.
Because you don’t own the actual investment, 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?
- Financial spread betting in the UK and Northern Ireland is a tax-free way of gaining exposure to the price movement of an asset. This is achieved by betting £x per point on the assets price movement (either up or down) and then cash settling the difference between the opening and closing price of the bet.
- You don’t currently have to pay Capital Gains Tax (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.
- CFDs are leveraged derivatives that enable clients to have exposure to changes in an asset’s price, without owning the asset itself. An opening CFD 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.
- If you make money on CFDs, you will have to pay 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.
Should you consider spread bets or CFDs?
Because of the extremely high-risk nature of these products.
However, you can lose much more than you originally deposited – the most likely answer is no.
Only consider these complex 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?
If things go wrong
Spread bets and CFDs are specified investments, which means firms advising on them or arranging them should be 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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