CFDs are often the best instrument for active traders, but UK and Irish traders may have a more tax-efficient method: what is known as ‘spread betting’. I will explain key differences between CFDs and spread betting, allowing you to decide which derivative is the best fit for your trading requirements.
Top Forex Brokers
What are CFDs?
A CFD (contract for difference) is a leveraged derivative product allowing the client to trade the price movements of the underlying asset with their broker without owning the physical asset. Traders still get exposure to corporate actions on shares, including dividend payments and stock splits, but do not pay shares stamp duty tax, as they never take possession/ownership of assets. This has made CFDs the primary derivative of choice for non-US traders (CFDs are not available in the US) where futures and options brokers are the primary way for traders to be short an instrument.
What is Spread Betting?
Many traders compare spread betting to gambling on a binary outcome, and because of this most professionals disregard it, as it does not involve trading in the traditional sense. Spread betting is only available to residents of the UK and Ireland. It is a leveraged derivative contract allowing traders to place a bet with a monetary value per point on the directional movement of the share price. The primary benefit of spread betting is that it is free of capital gains tax in the UK (unless you are classified as a full-time trading business), making it an excellent product for day traders.
CFDs vs Spread Betting Comparison
Before deciding on CFDs or spread betting, traders in the UK and Ireland who have access to both should review the below table to understand the differences and how then can benefit most from either method.
Features | CFD Trading | Spread Betting |
|---|---|---|
Availability | International, non-US | UK, Ireland |
Derivative instrument | Yes | Yes |
Leveraged | Yes | Yes |
Long positions | Yes | Yes |
Short positions | Yes | Yes |
hour dealing | Yes | Yes |
Stamp duty | No | No |
Corporate actions | Yes | Yes |
Capital gains tax. | Yes | No |
Direct market access (DMA) | Yes | No |
Corporate account | Yes | No |
Currency conversions | Yes | No |
Expiry | No (except futures CFDs) | Yes (but distant expiry times) |
Commission | Yes, percentage-based with minimums | No, spread only |
Hedging | Yes, traders can offset losses against taxable profits | Yes, but losses are not tax deductible |
Trade size | Number of CFDs | Account base currency per point |
Currency | The underlying currency of the CFD | The account base currency, usually £ (UK) or € (Ireland) |
Profit / Loss | Price difference multiplied by the number of CFDs | Price difference multiplied by the stake |
Pros and Cons of CFD Trading and Spread Betting
CFD trading and spread betting may appear similar in core aspects, but each has pros and cons. Traders should evaluate before deciding which leveraged derivative contract suits their trading style.
The pros of CFD trading and spread betting:
CFD Trading | Spread Betting |
|---|---|
Identical to trading physical shares | No stamp duty |
Leverage | No capital gains tax |
24/7 trading | No currency conversion fees |
Ideal for hedging | No commissions |
No stamp duty | Leverage |
Losses are tax-deductible | 24/7 trading is possible |
DMA access on shares | |
Tight spreads |
The cons of CFD trading and spread betting:
CFD Trading | Spread Betting |
|---|---|
Commissions | No tax deductions on losses |
Currency conversions | Only available in the UK and Ireland |
Wider spreads, financing costs can be expensive |
Who Should Trade CFDs?
CFD trading is ideal for traders seeking an identical approach to physical share dealing but without taking ownership of the underlying asset, whilst still enjoying the benefits of ownership such as corporate actions like dividend payments.
Traders who wish to hedge their physical shares, trade with leverage, get DMA access, require a corporate account, or reap the benefits of tax-deductible losses will also benefit from CFD trading versus spread betting.
Who Should Use Spread Betting Instead of CFD Trading?
Traders who want to trade international assets from their local currency, usually the British Pound for UK based traders and the Euro for Irish traders, will typically find spread betting a better choice. Spread betting is tax-free, giving it a significant advantage over CFD trading, and it is commission-free but often features wider spreads. Spread betting also affords greater transparency over price action moves, as a spread better can bet a certain amount, known as the stake, per point.
CFDs vs Spread Betting Example
Here is an example of how CFD trading and spread betting work from a trader’s perspective.
CFD trading example:
- Assume a trader bought 100 CFDs in Company XYZ at 50 and sold it at 52, the same as buying 100 physical shares.
- The profit equals 100 x 2 (the difference between the entry and exit point of the trade) or 200.
- A move from 50 to 48 would result in a 200 loss.
Spread betting example:
- Assume a spread better placed a spread bet on Company XYZ with a 100 stake per point, and the price moves from 50 to 52.
- The profit equals 200, the same as the CFD trade, but it is commission-free and a tax-free profit.
- A move from 50 to 48 would result in a 200 loss, the same as the CFD.
Conclusion:
The mechanics of a CFD trading and a spread bet are almost identical from the trader’s viewpoint, but spread betting remains tax-free and commission-free, therefore resulting in higher potential net income.
Bottom Line
CFD trading and spread betting may appear nearly identical on the surface but have legal and technical differences that traders should understand. The most notable advantages of spread betting are the lack of capital gains tax and the ability to trade international markets in local currency (GBP). For example, speculating on the price action of a Japanese company quoted in Japanese Yen with British Pounds.
CFDs are an excellent derivative contract for traders who seek exposure to price action without taking ownership of the underlying asset while functioning identically to physical share dealing.
