CFD vs. Spread Betting: What's the Difference?

CFD vs. Spread Betting: An Overview

Popular in the United Kingdom, contracts for difference (CFDs) and spread betting are leveraged products fundamental to the equity, forex, and index markets. Leveraged products offer investors the opportunity to get significant market exposure with a small initial deposit.

CFDs trades made in derivative instruments are cash-settled, and there is no exchange of physical goods. Spread betting involves speculation on the price movement of securities without taking any position in the security. Both types of trades are not allowed in the U.S.

What Are CFDs In Investing?

Contracts for difference, or CFDs, are derivative contracts between investors and financial institutions in which investors take a position on the future value of an asset. Differences in the settlement between the open and closing trade prices are cash-settled.

There is no delivery of physical goods or securities with CFDs, but the contract itself has transferrable value while it is in force. A CFD is thus a tradable security established between a client and the broker who are exchanging the difference in the initial price of the trade and its value when the trade is unwound or reversed.

Although CFDs allow investors to trade the price movements of futures, they are not futures contracts by themselves. CFDs do not have expiration dates containing preset prices but trade like other securities with buy-and-sell prices.

CFDs trade over-the-counter (OTC) through a network of brokers that organize the market demand and supply for CFDs and make prices accordingly.

What Is Spread Betting In Investing?

Spread betting, also known as financial spread betting or FSB, allows investors to speculate on the price movement of a wide variety of financial instruments. In other words, an investor makes a bet based on whether they think the market will rise or fall from the time their bet is accepted.

Investors also get to choose how much they want to risk on their bet. It is promoted as a tax-free, commission-free activity that allows investors to speculate in both bull and bear markets. The bet itself is not transferrable to anybody else.

Spread-betting companies provide buy and sell prices to potential investors who position their investments with the buy price if they believe the market is going up or sell price if they believe the market is due to tumble. Spread betting, unlike traditional investing, is actually a form of betting. Unlike fixed-odds betting, it does not require a specific event to happen.

You can actually close in the bet at any time and take home the profits or limit the losses. FSB is a margined derivative product that allows you to bet on the price movements of all kinds of financial markets and products, such as stocks, bonds, indices, currencies, etc. An investor can get into long or short bets depending on the prediction or direction the market moves.

Key Similarities of CFDs and Spread Betting

CDFs and spread bets are leveraged products whose values derive from an underlying asset. In these trades, the investor has no ownership of assets in the underlying market. When trading contracts for difference, you are betting on whether the value of an underlying asset is going to rise or fall in the future.

CFD providers negotiate contracts with a choice of both long and short positions based on the underlying asset prices. Investors take a long position expecting the underlying asset will increase, while short selling refers to an expectation that the asset will decrease in value. In both scenarios, the investor expects to gain the difference between the closing value and the opening value.

Similarly, a spread is defined as the difference between the buy price and the sell price quoted by the spread betting company. The underlying movement of the asset is measured in basis points with the option to purchase long or short positions.

Margin and Mitigating Risks

In both CFD trading and spread betting, initial margins are required as a preliminary deposit. Margin generally varies from 5% to 20% of the value of the open positions. For more volatile assets, investors can expect greater margin rates, and for less risky assets, less margin.

Even though the investors in both CFD trading and spread betting only contribute a small percent of the asset’s value, they are entitled to the same gains or losses as if they paid 100% of the value; however, in both investment strategies, CFD providers or spread betting companies can call the investor at a later date for a second margin payment.

Risk in investing can never be avoided; however, it is the investor’s responsibility to make strategic decisions to avoid severe losses. In both CFD trading and spread betting, the potential profits may be 100% equivalent to the underlying market, but so can potential losses.

In both CFDs and spread bets, a stop-loss order can be placed prior to contract initiation. A stop loss is a predetermined price that automatically closes the contract when the price is met. To ensure providers close contracts, some CFD providers and spread betting companies offer guaranteed stop-loss orders at a premium price.

Key Differences of CFDs and Spread Betting

Spread bets have fixed expiration dates when the bet is placed, while CFD contracts have none. Likewise, spread betting is done over the counter (OTC) through a broker, while CFD trades can be completed directly within the market. Direct market access avoids some market pitfalls by allowing for transparency and simplicity in completing electronic trades.

Aside from margins, CFD trading requires the investor to pay commission charges and transaction fees to the provider. Spread betting companies do not take fees or commissions. When the contract is closed and profits or losses are realized, the investor is either owed money or owes money to the trading company.

If profits are realized, the CFD trader will net the profit of the closing position, less opening position and fees. Profits for spread bets will be the change in basis points multiplied by the dollar amount negotiated in the initial bet.

Both CFDs and spread bets are subject to dividend payouts, assuming a long position contract. While there is no direct ownership of the asset, a provider and spread betting company will pay dividends if the underlying asset does as well. When profits are realized for CFD trades, the investor is subject to capital gains tax while spread betting profits are tax-free.

The Bottom Line

Spread betting and CFDs are both types of leverages investments. They have similar fundamentals, and the nuanced difference between them may not be apparent to the new investor. 

Spread betting is done over-the-counter and is free of commission fees. The profits are not subject to capital gains tax. CFD losses are tax deductible, and trades can be done through direct market access. With both strategies, real risks are apparent, and deciding which investment will maximize returns is up to the educated investor. Both are legal only in some countries. Neither CFDs nor spread betting is legal in the United States.