Spread betting on commodities is a modern method of speculating on the direction of commodity prices (as well as prices of other traded securities). When you place a spread bet, you bet your stake ‘per point’ of movement in the commodity price. Depending on the number of digits in the price, ‘one point’ may be equal to a dollar ($1), a dime ($0.1) or a cent ($0.01).
Therefore if you are trading gold, on CMC Markets a point is worth $0.1. So if you decide to use a stake of $1 per point, then if the price of gold rises by $10 , then you will have made 100 points profit multiplied by your chosen stake = $100.
Spread bets can be cancelled at any time between setup and expiry date. Therefore if you bet on a commodity going up and it spikes within 5 minutes of you placing the bet, then you can close out your position and take profit immediately.
Spread betting is a leveraged activity. This is because the amount of cash you actually need to fund your account with is far lower than the amount you would have needed to invest to achieve the same exposure in the underlying markets. To stick with the example of betting $1 per $0.1 movement in the price of gold, imagine that instead of placing a bet, you were buying gold to receive the same returns. To earn $1 from a $0.1 movement in the gold price, you need to own 10 troy ounces of gold. 10*$1,600 (current gold price per ounce) = $16,000 investment. Just to demonstrate, if gold rose to $1,600.10 then your holding would now be $16,001 or a $1 profit.
The spread betting provider however doesn’t require you to fund your account with $16,000 to bet $1 per point. Instead, it will probably only require you to fund it with $160. This represents leverage of 100-1, and it fairly standard among commodity spread betting providers. While this multiplies any gains, it also multiplies any losses. If you place a bet at 100-1 leverage, then the underlying asset only has to fall in price by 1% for your whole deposit to be wiped out.
For the use of leverage, you will be charged ‘financing costs’ over the duration of your bet, which is effectively an interest charge on the ‘debt’ you have taken out to leverage up your bet.
Spread betting allows you to bet against a commodity just as easily as betting on it going up. We call betting against a price ‘going short’, and shorting is one of the most exciting aspects of commodities spread betting. Let say you believe that commodities are overpriced, for instance you specifically feel that gold is overvalued. You can bet $1 per point that gold will go down, and profit from a price correction.
Due to the excessive leverage implicit in spread betting, volatility of any open positions is very high, leading to the risk of gamblers ruin. Gamblers ruin is similar to the fate of someone playing in a casino, or someone who rolls the winnings of one bet into another and another and so on. The problem is that you sit in the position whereby a 1% loss at any time will wipe out your investment. If your returns are volatile enough, then even if your investment has a positive expected return, you will always end up bankrupting.
Consider this graph as an example. The blue line shows the performance of a commodity over time. This shows the wealth of an investor who invested 100% equity and used no leverage. The red line shows an investor who used 10-1 leverage, and therefore sees gains and losses magnified by a multiple of ten. While the commodity initially moved up in period 3, the leveraged investor had doubled their wealth, however when the commodity dropped to below 90% of its starting value temporarily, the leveraged investor wiped out and lost their funds.
So even though the investment had a strong long term performance, the leveraged investor lost everything. This demonstrates the damaging effect of leverage in volatile markets. Unfortunately, markets appear to be getting more volatile all the time due to the uncertainty we’re currently facing. Read more about the dangers of leverage.
There is also the risk that a stop-loss order you place (to protect yourself from losses should a commodity fall below a given value), does not execute correctly. This sounds surprising but it does happen, and unfortunately can take place when a commodity price moves too quick and ‘skips’ your stop loss price. This presents the risk that you may lose more than your initial deposit – this is the risk warning you will see on spread betting sites a lot.
Advantages of Spread Betting
So I’ve detailed some of the risks of spread betting, but now I’d like to explain why despite these risks, many people do engage in spread betting.
Tax Free (UK as of writing)
Due to spread betting’s status as ‘gambling’, proceeds are not subject to capital gains tax. This means that investors who have utilised their full ISA allowance for the year may be able to take long positions more efficiently through spread betting. Importantly, spread bets on UK shares/ETFs don’t charge stamp duty (0.5%) either.
Can utilise cash elsewhere.
Leverage can actually work in your favour if you plan to invest it in risk free securities elsewhere. The financing charges that spread betting companies charge are relatively low, this means in the absence of any other significant charges, you could potentially borrow 99% of your bet and pay 3% per year, whilst investing the 99% you saved and earn 4% per year, which slightly increases the odds in your favour.
Which Commodities can you Spread Bet?
Here is a list of the commodities available for spread betting from CMC Markets.
Gold Spread Betting
Sugar White Spread Betting
Soybean Oil Spread Betting
Gasoline Spread Betting
Soybean Meal Spread Betting
Silver Spread Betting
Crude Oil Brent Spread Betting
Cocoa Bulk Bean Spread Betting
Copper Spread Betting
Soybean Spread Betting
Sugar Raw Spread Betting
Wheat Spread Betting
Heating Oil Spread Betting
Crude Oil West Texas Spread Betting
Natural Gas Spread Betting
Corn Spread Betting
Coffee Robusta Spread Betting
Overall Evaluation of Spread Betting for Commodities
If this article were about shares and indices, I would quickly state that trading shares through a broker is more efficient and less risky. However even in the traditional markets, it is difficult to gain access to the spot price of precious metals and resources. The merit of spread betting is its simplicity and ease of use. While commodities spread betting incurs financing and often holding charges (costs of theoretically taking possession of the commodity) which can add up in the long run, the same can be true of investing in derivatives, which offer similar spot price exposure.
At Financial Expert, I don’t recommend short term speculation because of the inherent difficulty in making profits, and the small fraction of traders that actually manage to do so. However, if you have a strong view on the direction of a commodity over the short term then I believe spread betting is the most efficient method of making that trade. Be careful of using too much leverage – remember that by adjusting the size of the stake relative to the cash in your account, you can effectively de-leverage your returns. Always place stop losses.
To learn more about how to start investing in commodities visit our main article.