How to profit from a quiet summer

Now could be a good time to place some promising spread bets while markets take their traditional summer breather. Tim Bennett explains how.

Is this a good time or a bad time to be a spread betting broker? If you think you know the answer you could take a bet on the shares of a listed spread betting firm.

On the plus side

On the face of it, this looks like a great time to be in the business of providing spread betting services. In the wake of the financial crisis, many of the market's volatility measures spiked to incredible highs.

Take the Vix a derivative-based indicator published by the Chicago Board Options Exchange. Having pottered along at a level of around 13-17 for years it shot up to over 80 at the height of the crisis. That signalled extreme equity market volatility, and therefore lots of opportunities to place directional bets.

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Since then, we've had the sovereign debt crisis, the threat of a Chinese slowdown, and multiple central bank policy responses to keep anyone who tracks, say, the foreign exchange markets busy.

Meanwhile, there has been a surge in retail investor interest in spread betting in recent years, as more and more people realise it is an easy and tax-free way to take a bet on almost anything.

Take the Olympics you can bet on who will win individual Olympic events and medals, to how far the share price of embattled security firm G4S will tumble after their embarrassing failure to provide enough staff. You name it it's probably possible to spread bet it these days.

However, there are also threats looming when it comes to making money as an intermediary.

On the downside

The first is that markets have gone much quieter. Sure, the FTSE can still put in little surges as, say, the Bank of England announces more liquidity measures. And Europe still has the potential to frighten foreign exchange traders as Spanish debt yields hover at historic highs of around 6-7%.

But the sickening lurches in stock exchanges and currencies that were a feature until recently have abated for now. So, with the Greek elections behind us, the summer could be relatively quiet in Europe. Less volatility (the Vix is back down below 20 and has been for some months) means less spread betting.

The next threat is regulation. Europe is still deliberating some sort of transaction tax ('Robin Hood' or 'Tobin' tax) that could hit all derivatives trading. Meanwhile, the Japanese have already introduced tighter criteria around leveraged trading, as has Singapore. Globally, regulators are looking at ways to reduce risky behaviour and, rightly or wrongly, they have the derivatives market in their sights.

Thirdly the rush of spread betting brokers into the market has put pressure on spreads - as they narrow, brokers generally make less money per trade and rely on heavier traffic instead.

That's fine when the market is busy but not when it slows. And given that many brokers suffer high operational gearing - fixed costs are a big percentage of total costs - margins can be squashed when revenues slip.

What to do

You can easily spread bet the shares of a listed firm such as IG Index. It's had a good 12 months with a 16% increase in sales and a £12.5m boost to pre-tax profits of £185.7m. And with solid cash flows and a healthy dividend, it's not about to fall off a cliff.

But analysts increasingly question where growth is now going to come from in less exciting markets. If you agree with them, now could be a good time to short the company while markets take their traditional summer breather.

Tim graduated with a history degree from Cambridge University in 1989 and, after a year of travelling, joined the financial services firm Ernst and Young in 1990, qualifying as a chartered accountant in 1994.

He then moved into financial markets training, designing and running a variety of courses at graduate level and beyond for a range of organisations including the Securities and Investment Institute and UBS. He joined MoneyWeek in 2007.