Spread Betting and Arbitrage

written by spread bettor

Introduction

In the financial markets, there is a gamut of products available which a trader can use to customise a trade to his specification. This can be done by utilising derivative products on the exchange using futures and options or through customised over-the-counter products such as spread betting.

What is financial spread betting?

Financial spread betting is a method of trading, which involves placing a bet on the movement that the underlying instrument is expected to take. Typically carried out over-the-counter (OTC), spread bets are an extremely high leveraged form of trading. A broker that offers spread betting provides two quotes, i.e. The bid and the ask for the underlying instrument. These quotes are the spread. A trader aims to predict whether the underlying instrument will fall below the bid price or rise above the ask price and accordingly places a bet on the expected outcome. As it is an extremely leveraged form of trading, a bet in the right direction can provide compounded returns. However, the same is also applicable to losses incurred. It is, for this reason, important that investors fully understand the extreme risks involved in entering into such trades.

Eg. If a broker quotes the EUR/USD pair having a bid price of 1.2500 and an ask price of 1.2510. A trader can either bet that the price will rise above 1.2510 or fall below 1.2500. If he bets £1 for every pip that the pair rises above 1.2510 and then the price rises to 1.2520, he will make a profit of £10. Similarly, if it falls to 1.2500, he would lose £10.

Arbitrage opportunities while spread betting.

Arbitrage, in the case of spread betting essentially, involves taking advantage of a difference in the price quoted by two different brokers and is essentially a risk-free form of trading. An arbitrage opportunity arises when a broker who accepts spread bets provide quotes that are significantly higher or lower than the other brokers quote. This enables a trader to take offsetting positions with the two brokers. The final result being the traders profit is equal to the difference in the two quote multiplied by the volume of the bet placed.

Eg. A broker quotes the EUR/USD pair at a bid price of 1.2550 and an ask price of 1.2560. While another broker quotes the same pair at a bid price of 1.2580 and an ask price of 1.2590. As there is a difference in the Bid/Ask price of the two brokers, an arbitrage opportunity exists. Since the ask price of the first broker is lower than the bid price of the second broker, the trader can take advantage of this by betting £5 for every pip above the ask price with the first broker. The first trade is offset by betting £5 for every pip below the bid price with the second broker. The final result being that irrespective of the direction in which the currency pair moves in the future, the trader will be able to make a profit of £100 (£5*20pips).

With this trade, the profit is assured irrespective of the direction in which the currency pair moves; it is an extremely safe and risk-free form of investment. However, with the advent of advanced technology, these opportunities are extremely rare to come across and can disappear in a fraction of a second.