FOOL SCHOOL
Alternatives To Spreadbetting

June 11, 2004

Spreadbetting and CFDs operate in a very similar fashion although there are two main differences. Firstly your gains on CFD trading are liable to Capital Gains Tax (and you can offset losses against other taxable gains that you make). Secondly, you can often deal inside the quoted spread with a CFD account.

However, there are also a number of other ways you can bet on short-term price movements, both up and down.

Futures
A futures contract is an agreement with another party that you will buy or sell a particular asset at a particular price at a particular time. For example, you might agree to sell the 100 shares in Wonky Widgets for 120p in 100 days' time.

Like spreadbetting and CFDs, you can close the transaction, before the 100 days have passed, by making an opposite bet. Or you can wait until the expiry date and fulfil the terms of the agreement. Like CFDs, futures are exempt from stamp duty but are liable for capital gains tax. You will usually have to deposit a margin to cover potential losses but, unlike CFDs, there are no financing charges for keeping a bet open.

Options & Covered Warrants
Options give you the right to buy (or sell) an asset at a particular price and at a set time. They differ from futures, where you are obliged to fulfil the terms of the agreement (unless you negate it by making an opposite bet).

So you could purchase an option that allowed you to buy 100 shares in Wonky Widgets at 100p in 100 days' time, should you choose to. If the current share price was 100p then this option might cost you 10p today. If the price of Wonky Widgets was only 90p when the option expired then its value would be zero. Why would you exercise an option to buy at 100p when you can get the shares for 90p in the open market?

However, if the price rose to 120p by the time the option expired, then that option would be worth around 20p, reflecting the fact you could exercise your right to buy shares at 100p and immediately sell them in the open market for 120p.

An option to buy a share is known as a 'call option' because you have the option to 'call' for the shares. You can also buy an option to sell shares to someone else at a particular price. This is known as a 'put option', because you have the option to 'put' the shares to someone.

Covered warrants are very similar to options, giving you the right to buy or sell a share at a particular price and at a particular time. Trading in covered warrants was opened up to private investors in October 2002.

Because you have a choice to act, buying an option or covered warrant means that your losses are limited to the initial purchase price. As with basic spreadbets, though, if you were to start shorting them, then your potential losses would become unlimited.

This makes options and covered warrants a little less risky than futures, CFDs and spreadbetting. But we should qualify that. It's less risky in the same way as putting your head in crocodile's mouth is less risky than putting it in the mouth of a Great White Shark.

Both options and covered warrants are exempt from stamp duty but not from capital gains tax. Remember though that tax laws could change in the future which could make these methods of trading less attractive.

Find out more in our spreadbetting centre.