Why spread bet on an ETF?

ETFs are simple, straightforward and effective. So why complicate them with spread betting? Tim Bennett explains.

Exchange traded funds are well known to many investors. They are shares that passively track an underlying index, sector or asset (say the price of gold). They benefit from being simple, cheap and usually very liquid. So why make life more complicated by combining an etf with a spread bet? The answer is to more accurately short sell (bet on falling prices).

ETFs that simply go long that is track say the FTSE 100 directly are very useful and do pretty much what it says on the tin. So for example, assuming there are no foreign currency considerations, a 1% movement in the underlying index will result in roughly a 1% movement in the ETF.

But this falls down when it comes to inverse ETFs. Marketed as a way to short the market, you might think they'd say rise 1% for every 1% fall in the underlying index or sector. But you'd be wrong - and the reason is daily repricing. So for example an index might be at 100 and then rises 10% (to 110) before falling 20%. So now it is at 88. Say you had bought an inverse ETF at a price of £100 to track it. On day one the ETF falls 10% to £90, as you'd expect. But then on day two it rises 20% to £108. So the index is down 12%. Yet the ETF is up just 8%, not 12%. That's not the exact inverse relationship many investors will be expecting.

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That's where shorting an ETF comes in, using a spread bet. It's no fiddlier to set up than buying the inverse ETF and it avoids the annoying repricing performance problem above. And because a spread bet is geared your deposit is only a small proportion of the underlying exposure - you can effectively gear up the bet as much as you want (or your broker will allow).

Don't forget though that shorting anything is risky (losses are in theory unlimited if the bet backfires) so always consider stop losses. This is especially important where you short an ETF "naked" that is you have no underlying long position and thus the short spread bet is not hedged.

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.