Should you bet on the spread betters?

In December, Britain's financial watchdog unexpectedly proposed a raft of new regulations that would hit spread-betting firms. The Financial Conduct Authority (FCA) wants to tighten up the rules on promoting spread-betting products; to crack down on short-term binary bets; and to impose tighter limits on the amount of leverage (borrowed money) that betters can use.

The proposals are a mixed bag. The approach to marketing and transparency is sensible, and we're certainly no fan of binary bets, financial or otherwise (see below for more). However, the proposals on leverage are arguably overly restrictive, especially for consumers whom the FCA views as "inexperienced". Indeed, far from making consumers safer, tightening leverage limits too drastically could put them at further risk by pushing them to use unregulated offshore operators.

In any case, regardless of your views on the rules, the changes hit the share prices of spread-betting companies hard, as investors fretted that profits would tank. The share prices of IG Group and Plus500 fell by more than 40% in a matter of hours, while CMC Markets halved. Since then, they have bounced back a little. However, the share prices of both IG and CMC are still around 30% below where they were before the FCA dropped its bombshell. So should you bet on prices rallying further, in the hope of the FCA moderating its stance, or is that a gamble too far?

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There has certainly been a sizeable backlash against the FCA proposals. According to the Financial Times, the regulator has received more than 2,500 submissions on this topic; usually it's closer to 150. Obviously the FCA doesn't have to accept these comments, and there are already complaints that spread-betting firms have been encouraging their users to write in. Some of the replies may even endorse the FCA's proposal. However, it's a safe bet that the vast majority were critical, and that the FCA would look high-handed if it completely dismisses them.

The FCA will also consider the fact that any big increases in regulation run the risk of causing job losses at a time when Britain's pending exit from the European Union is causing more than enough angst over the future of the British financial services industry as it is. So my guess is that in the end, the FCA will compromise by watering down its proposals.

A revised set of regulations would focus on curbing some of the worst practices, such as marketing that downplays the risks of spread betting, and companies that allow clients to run up huge debts. Indeed, the FCA could do worse than follow the pragmatic example of the German regulator, which is set to force spread-betting firms to offer no-negative account-balance guarantees.

This would improve consumer protection while allowing a cleaned-up industry to keep on growing. And even if the FCA doesn't make significant changes, it might delay the implementation, which would give firms an opportunity to see how they can work within the rules. As a result, I believe there's a good chance that when the final rules come out we will see a big improvement in market sentiment towards the sector.

Of the three major listed firms, IG Group (LSE: IGG) has the most to offer investors if it can weather this storm. IG's revenues have been growing at around 8% a year for the last five years. It is also diversifying away from spread betting towards more traditional brokerage services, and it has recently started offering clients access to initial public offerings. In terms of valuation,IG looks attractive at just 12 times current earnings, and yielding around 5%. I suggest buying it at 570.5 at £2 a point, with a stop-loss at 285. This means your maximum downside is £571. Whatever happens, I intend to close this position shortly after the FCA's final proposals come out.

How to spread bet on the general election

Spread-betting firms are offering the opportunity to bet on a number of general-election related markets. The two major providers are Sporting Index (SportingIndex.com) and Spreadex (Spreadex.com). The most straightforward market is the seats market, which functions like any normal spread bet.

For example, if you buy Labour seats at 173-179 at £5 per seat and they end up with 200, you would win £105 (21 x £5). However, if you had instead decided to sell, you would end up losing £135 (27 x £5). There are similar prices for the Conservatives (382-385), Liberal Democrats (13.5-16.5), Ukip (0.1-1), SNP (44-47) and Greens (0.75-1.75).

Both Sporting Index and Spreadex also offer binaries. Simple binary bets expire at one of two values, depending on the outcome. So a binary on the Conservatives winning most seats would expire at 100 if they do, but 0 if they don't. The amount you would win or lose would depend on the difference between the price at which you bought (or sold) the bet, the final outcome and the stake per point.

For example, Sporting Index is currently quoting 91-97 on the Conservatives winning the most seats. If you bought the binary at 97 at £2 per point, you would make £6 if they came first (100 - 9 x £2). However, if they lost, you would lose £194 (0-95 £2). If you had instead sold, you would make £182 if they lost, and lose £18 if they came first.

Sporting Index is also offering two complex binaries: "Rhapsody in Blue" (Conservative seats) and "Scots Wha Hae" (SNP seats). Like binaries, these bets run on a 0-100 scale. However, they are on a graduated scale, with a certain number of points for each outcome. For example, in the case of the Rhapsody in Blue bet, 300 or less counts as 0, 310-325 counts as 5, all the way up to 100 points for 501 or more seats.

As with any spread betting, you need to be aware of the risk that you are taking. However, we'd stay away from binary bets since the wide spreads on such bets mean that they represent poor value. Unless you want to make a spread bet on the number of seats, you would get better odds from a bookie or a betting exchange.