Skeptics have long compared stock markets with casinos, with brokers as thinly disguised bookies. Guess what? In Britain, at least, some bookies are now acting like brokers and taking wagers on the directions of stock markets, an exercise called spread betting. The fad is rapidly gaining converts among serious investors as an innovative way to play markets, though a lot of others remain, well, skeptical.
Spread betting first hove into view in the mid-1970s, when a British sports bookmaker--betting is legal in Britain--devised an esoteric, high-risk means of gambling on the future of market indices. Instead of betting the fixed odds of a victory, a fan can bet the point spread on a vast array of future movements; today bets can be made on just about any indicator, including indices, share prices, currencies and commodities. Though spread betting occasionally looks the same as dabbling in futures markets, typically the bets are smaller and more specialized, an attraction for the individual investor. An estimated 50,000 Britons regularly use financial spread-betting services, and industry executives expect that number to grow by 60% a year.
Here's how it works: a betting firm offers a spread--the range from the buy quote to the sell quote offered by the bookmaker--on, say, what the level of London's Financial Times Stock Exchange 100 Share Index will be three months hence. 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 an index point (the bet amount can, of course, vary). The market does indeed drop 150 points, to 6,550, and you collect $2,250 in the example. But if the market goes up, your losses could be just as dramatic. Losses, however, can be kept to an agreed-on-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 the bookies usually profit by adjusting their spreads and by constantly trading in the underlying markets to hedge clients' bets. 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, a London-based firm that pioneered financial spread betting 26 years ago and remains the market leader. IG Index set up shop as a financial spread-betting bookmaker, initially offering spreads on gold futures, hence its name.
The concept took root in Britain, where there's no tax on gambling winnings but where capital-gains taxes can run as high as 40%. Betting transactions also don't incur the .5% duty the British government levies on stock transactions and are free of fees and brokerage commissions. 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 will earn money on both the down and the up sides. London dentist Sarab Singh, 35, has been spread-betting for about a year and at one time was up about $1.4 million. He has lost most of that but doesn't let his spread betting affect his investment portfolio, which he says "is more long term."