Spread betting: beware the margin call

For share investors, one aspect of spread betting can be puzzling at first margin. And not understanding how it works could also be expensive.

When you buy shares, you typically pay the whole purchase price up front. Simple. However, this means you have a lot of 'skin in the game', in the form of committed cash. Spread betters on the other hand only have to fund a small proportion anywhere typically between about 5% and 20% of the initial value of a position.

So, for example, if you place an upbet on the FTSE 100 at 4,900 points for £10 a point, your theoretical exposure is £49,000 (4,900 x £10) if the bet backfires (since the FTSE could drop to zero). However, spread betting brokers recognise that this is highly unlikely, so you might get away with a deposit of just a small percentage of that amount. This is how spread bets are 'geared' and allow you to take relatively large bets with a fairly small initial outlay.

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However, here's the rub: once you have paid for shares, you can simply run a loss-making position by not selling them until they rise in value. Spread betters on the other hand cannot run losses this way.

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In the above example, if the FTSE drops, and you try and maintain an open upbet, your broker will demand more margin. This is often called "variation" margin. It is paid in cash on top of any initial deposit, and must continue to be paid daily to keep a position running. A failure to pay gives a broker the right to close out your position, even if it's at a loss to you.

So be prepared. Make sure you have access to sufficient funds to pay variation margin calls. And use stop losses that way you know what your maximum cash loss is likely to be from the start. Many brokers insist on these for novices, but always check with yours before trading.