A common use for spread betting is to hedge (offset risk) in an existing portfolio.
Hedging is a way to protect yourself if the commodity or stock you are trading should take an unexpected dive, if you’ve gone LONG, or spikes up, if you’ve gone SHORT. You can also use spread trades to hedge your regular, traditional, non-spread trade positions in shares or commodities.
Let’s say at the beginning of 2008 you think the market is going to be in for a really hard time because of the emerging financial crisis. You already own stocks like IBM, Barclays, Google, and Citibank among others. You could simply sell all your shares at the beginning, and then buy them back at the lower prices months into the crisis. But if you did this, you’d have to pay capital gains taxes on each stock when you sell it. And then you’ll have to pay them again when you eventually sell what you bought at lower prices.
But as there are no capital gains involved with spread trading, you can make a spread trade to go SHORT (sell) the FTSE100, NYSE, or NASDAQ (all three for example, or just one, or specific shares within them). Let’s say the FTSE100 dropped 20%, and your specific shares fell by a similar rate. But because you hedged your trade by doing a spread trade to sell, you’ll have made 20% on that trade, which will offset the 20% you lost on your existing shares in your account.
As an example -:
An investor holds 100 ounces of gold, which after a rapid run-up is currently valued at $1000 an ounce, giving a market exposure of $10000. The investor thinks that the price is likely to temporarily fall over the coming months, but does not wish to sell due to trading costs, and wishes to lock-in his profits.
As it stands, for every dollar the gold price falls, the investor stands to lose $100.
Therefore that investor chooses to place a sell bet for $1 per cent on the gold price.
Any drop in the investors original portfolio will be made up for by profit on the bet, conversely, if the gold price continues to rise, the profits on the investors original portfolio will be consumed by the losses on the bet – effectively making him ‘market neutral’ for the duration of the bet.