Difference Between Spread Betting and other forms of trading
Financial trading can seem overwhelming complicated to new traders, however it is possible to make some differentiation between different trading products offered by various brokers today, note that some traders combine one type of instrument with another to make an overall better trading strategy, such as spread betting together with binary options, or stock options together with CFDs.
The foreign exchange market (Forex):
The foreign exchange market is all about trading currencies, compared to other trading instruments currencies offer tax free dealing, very high leverage (up to 400:1), high liquidity (market participation), and some sense of stability since prices tend to be less volatile than stocks. Forex brokers are generally market maker type, or ECN type, a market maker broker is very similar to a spread betting type broker, whereas an ECN broker facilitates each trade separately, each single trade has to reach the market out in the outside world, short trades don’t cancel out with long trades in the broker’s system, and each trade is subject to overnight interest charge or credit.
Binary options combine the advantages of both fixed odds betting and spread betting in one instrument, the binary option is simply trading the probability of a prediction coming true, the payout of a binary option depends on that probability and varies all the time until expiration. Typical payout of a daily binary option on the daily FTSE100 London market is up to 80%, this means that the trader buys a binary option that the FTSE100 will close up for the day, and pays ₤100, if the FTSE100 closes higher for that day, when the option expires, the trader will receive ₤180, if he was wrong he would lose a maximum of ₤100, as is the case in traditional fixed odds gambling. If the trader wanted to close the bet early he could have done so half way into the trading session, by selling back the open binary option, and depending on where the FTSE100 was, at that time, and the time of the session, it could have been worth ₤100, ₤70, ₤30, or ₤150. Binary options are great for longer term trading, or at least speculating on market’s daily closing price, but are not suitable for very short term trading and certainly not as profitable as spread betting. So if you were looking to capture a tiny price movement on say ₤/$ of about 30 points, then spread betting or spot forex is the way to trade, a binary option will fail to make any profit, but if you ware to capture many points, say 300 points over 2 weeks, then a binary option maybe better, in fact in some cases of long dated binary options the payout can be greater than 80%, it can be as high as several 100s %, but you have to be accurate in timing the market, because as time passes the binary option loses its value.
CFDs (Contracts for Difference):
CFDs are very similar to spread betting, hey work pretty much in the same way in they way they are traded, and on margins requirements, they are however some key differences. A CFD contract doesn’t have expiry date, whereas a spread betting contract does, also CFDs are subject to capital gains tax, spread betting isn’t, and finally CFDs are subject to overnight interest charge or credit depending if the trade is long or short respectively, spread betting contracts have this premium priced in the spread price, but it’s much less, because of the way spread betting is facilitated where most long trades cancel out with short trades, with CFDs it’s different, even if the broker keeps 100 long trades and 100 short trades they are obliged to charge and credit the fully applicable overnight rate.
Option are much more complicated instruments, they have been around since the early 70s, and they have significant differences to all other instruments discussed in this article, they are subject to capital gains tax and slightly influenced to interest rate changes ( change of rates, not overnight rates), they are also heavily influenced by volatility and other factors. Options work very similar to car insurance, they are better understood if you think of them as car insurance premiums, where volatility of price of the underlying commodity is the barometer of risk. With options you can be either the underwriter or buyer of insurance, or both, as the stock or commodity in question fluctuates more and more volatility increases hence premiums go up and vice versa. You can easily see the parallels here with car insurance premiums, when a driver drives carefully and never has an accident their ‘volatility’ goes down, and so does their premiums and vice versa. With options it’s the same thing because volatility in commodity prices is a measure of financial risk. Apart from all this, options work in a complicated way, their premium contains a non linear structure and therefore options don not necessarily move dollar for dollar with the underlying commodity. As a result it is possible to make complicated trades where the trader can win $1000 if the underlying stock rises by $1, but only lose $700 if the same stock dropped $1, this you cannot do with any linear instrument.
Options have expiry date much like binary options and spread betting contracts, they are however much more complicated to trade due to their parameters and are only suitable for experienced traders.