When Your Broker Is a Bookie

For the past few years the gyrations of financial markets have led skeptics to compare them to casinos in which investors bet on their hunches as to which way a market is heading and brokers are thinly disguised bookies. Guess what? In Britain, at least, some bookies are like brokers taking wagers on the directions of markets in something called spread betting. It is rapidly gaining converts among serious investors as an innovative way to play the markets.

Spread betting evolved in the mid-1970s when a British sports bookmaker devised an esoteric, high-risk means of gambling on the future of market indices that in time became popular on sporting events too. The advent of small investors in the stock market has fired the current boom in financial spread betting. Today bets can be made on the future movements of just about any indicator including indices, share prices, currencies and commodities. An estimated 50,000 Britons regularly use financial spread betting services, and industry executives say the market is growing by 60% a year.

Here's how it works: a betting firm offers a spread the range between the buy and sell quotes offered by the bookmaker on, say, where the Financial Times Stock Exchange 100 Share Index will be in three months. Let's say the spread is 6,700 to 6,710. You think it will be a bearish market, so you sell at 6,700, at $15 a point (the bet amount can, of course, vary). The market does indeed drop 150 points, to 6,550, and you collect $2,250. If, however, the market had gone up, your losses could be just as dramatic. Losses, however, can be kept to an agreed-in-advance limit; and whether you're winning or losing, you can close your position at any time.

This is one game where the bookies like it when customers win. Why? Partly because they usually profit by adjusting their spreads and from constantly trading in the underlying markets to hedge clients' bets. And more often than not, they come out ahead. "Last year, our clients made more than they lost, yet we had a record year as well," says Michael Murray, associate director at IG Index, which pioneered financial spread betting 26 years ago and remains the market leader.

The concept is particularly alluring in Britain where there's no tax on winnings. And, unlike stock transactions, the bets incur no .5% stamp duty either. They are free of fees and brokerage commissions too. Increasingly, investors are using spread betting not just to make quick and large gains on price and market swings, but also to hedge their investments. For example, if you want to keep shares in your portfolio as a good long-term investment but think the price may fall in the short term you take a sell position with a spread bet, and keep your portfolio intact. If you're right, you'll earn money on both the down and the up sides.

Still, spread betting is very risky and losses can rapidly pile up. Clients are vetted to ensure that they can handle the worst. "We don't want any widows and orphans," Murray says. While the hard-core clients tend to be financial pros and experienced investors, the expanding market is attracting less sophisticated punters.

The arrival last May of newcomer Cantor Index, a subsidiary of American brokerage Cantor Fitzgerald, has also energized the industry. "Spread betting was viewed as downmarket, but Cantor has helped legitimize it," says Kevin Taylor, managing director of rival Financial Spreads, which was launched in April 1999. Cantor boasts it will have 10,000 accounts by next May, helped by the migration of spread betting to the Net. While IG Index went online first, Cantor hit the Web with a service it claims is faster. David Buik, Cantor head of marketing, predicts that within two years, 70% of the market will be Web-based. Though tax and gaming laws tend to be tougher on the Continent, Buik says spread betting will cross the Channel within a couple of years, "once we take the word bet out of it" and sell it as an investment tool.

Still, it's unlikely that betting operations will take much business away from established brokers. "Spread betting doesn't replace a long-term investment strategy," admits Ed Nicholson, head of financial marketing at City Index. But brokerages are likely to move into spread betting following Cantor Fitzgerald's lead. "I'd be amazed if they don't. It's a very good product that hasn't been marketed very well," Buik says. If he's right, a growing acceptance of financial bookies is in the cards.