Options vs. Spread betting: A side-by-side comparison

In the world of financial trading, choosing the right strategy can be daunting. This is particularly true when deciding between options trading and spread betting, two popular but distinct approaches.

My side-by-side comparison of options vs spread betting breaks down the basics, risks, and rewards of each, offering clarity and guidance.

Whether you're a seasoned trader or new to the game, this comparison aims to simplify your decision, helping you align your trading strategy with your financial goals and risk tolerance.

What is spread betting?

Spread betting is a type of financial derivative where traders bet on the direction of price movements in various financial markets, without actually owning the underlying assets.

This method allows traders to potentially profit from markets that are moving up or down. When spread betting, a trader predicts whether the price of an asset will rise (going long) or fall (going short).

The amount of profit or loss is determined by how accurately the trader predicts the price change and the extent of the movement in price.

Pros and cons of spread betting

Pros:

1. Tax benefits: One of the major advantages of spread betting is its favourable tax treatment. In many jurisdictions, profits from spread betting are not subject to capital gains tax, making it a more financially efficient trading option.
2. Access to diverse markets: Spread betting opens the door to a wide variety of markets and financial instruments. Traders can speculate on everything from individual stocks to entire indices, commodities, and even currency fluctuations.
3. Flexibility in trading: This method allows traders to implement flexible strategies. They can capitalise on markets that are moving upwards or downwards, offering more opportunities to profit.
4. High leverage potential: Spread betting often offers high leverage, meaning traders can control large positions with a relatively small amount of capital. This can significantly increase the potential for returns.

Cons:

1. High risk and volatility: Spread betting carries a high level of risk, including the potential for rapid, significant losses due to market volatility. It's not suitable for everyone, particularly those with a low-risk tolerance.
2. Dependence on market predictions: Success in spread betting hinges on the trader's ability to accurately predict market movements. This can be extremely challenging, even for experienced traders.
3. Risk of addiction: For some individuals, the thrill of spread betting can lead to compulsive gambling behaviours and addiction, posing a serious personal risk.
4. Limited protection: Compared to more traditional financial markets, spread betting may offer less investor protection and regulatory oversight, which can increase the risk of malpractice and fraud.

What is option trading?

Options trading involves the buying and selling of options contracts. These contracts grant the buyer the right to buy or sell an asset at a predetermined price within a specific time frame but without the obligation to do so.

Imagine you predict that the price of US crude oil will increase from $50 to $60 per barrel in the coming weeks.

To capitalise on this, you buy a call option, giving you the right to purchase the oil at $55 per barrel anytime within the next month. The cost of acquiring this option is called the premium.

Pros and cons of option trading

Pros:

1. High upside potential: Buying options offer significant profit potential, limited only by the option's premium.
2. Useful for leverage: Options can magnify investment power, providing higher returns on the same investment amount compared to buying actual shares.
3. Effective for risk hedging: Selling put options can be a strategy to hedge against risk in an existing investment portfolio.
4. Limited losses: Losses are confined to the premium paid when buying options, offering a degree of loss containment.

Cons:

1. Risk of worthlessness: Options can expire worthless if the underlying asset doesn’t move as expected, leading to a total loss of the premium.
2. Complexity and pricing challenges: Options are complex financial instruments that are difficult to price accurately, requiring advanced investment knowledge.
3. Potential for large losses: Despite the capacity for high returns, options also carry a risk of significant losses, especially if not fully understood.
4. Unlimited risk in selling options: When selling options, there's a theoretically unlimited risk involved, with profits limited only to the received premium.

Exploring the key differences between spread betting and options trading

The analysis in this section explores the primary differences between spread betting and options trading, emphasising their specific features such as the sizes of trades, the types of asset classes they involve, and their respective settlement methods

The comparison provides insight into the operational aspects of each strategy, demonstrating how they cater to different investor needs and risk profiles. The aim is to assist traders in selecting a strategy that aligns best with their investment goals.

Expiry date

Both spread bets and options have expiry dates. For options, this date is when the contract can be executed at the strike price. You can close the option any time before or on this date. If not used by the expiry date, the contract becomes worthless.

Options can have daily, weekly, or monthly expiry dates, often ending on specific calendar dates, like the third Friday of the month for U.S. stock options.

In contrast, spread bets have a set duration, from a day to several months. You can close these bets any time before their expiry.

Asset classes

Options trading typically includes stocks, forex, and commodities, which allows traders to focus on these markets with tailored strategies.

Alongside these, our services extend to trading stock indices, futures contracts, and interest rates, catering to a broad spectrum of financial interests.

Conversely, spread betting encompasses a more extensive array of markets, not only covering all the assets available for options trading but also including bonds, providing a one-stop solution for investors seeking exposure to a diverse range of financial instruments.

Ownership of assets

Options can be settled in two ways: physically, by receiving the actual asset, or through cash, by settling the value difference.

Spread bets always settle in cash, so you don't own the underlying asset, making them tax-free.

Medium of exchange

Most options are traded on exchanges like the CBOE and are standardised. Some options, known as exotic options, are traded over the counter (OTC) and offer more flexibility.

Spread bets are also OTC transactions, allowing customised agreements tailored to your strategy. They are more flexible than exchange trades.

Trade sizes

Options trade in lots, representing several assets. For instance, a single share option might cover 100 shares.

Spread bets let you choose your bet size, with profits or losses calculated based on the difference between opening and closing prices, multiplied by your bet value.

Which investment is better?

Determining a more suitable investment between spread betting and options trading relies on individual investment goals, risk tolerance, and market understanding. Each strategy serves distinct investor needs and preferences.

Spread betting:

• Investors speculate on price changes across various financial markets without owning the actual asset.
• It offers tax efficiency and the ability to trade on margin. Profits or losses hinge on the accuracy of the bet about market movements.
• Suitable for those seeking tax-free gains and leverage, spread betting also carries significant risks due to its leveraged nature.

Options trading:

• Purchasing contracts give the right, without the obligation, to buy or sell an asset at a pre-set price before a certain date.
• This strategy is versatile and useful for both hedging and speculating on market trends. Risks are typically confined to the premium paid for the option.
• Attracting investors who aim to limit risk while maintaining the chance for substantial returns is a key characteristic.

The decision rests on one's financial situation, investment experience, and comfort with varying levels of risk. It's beneficial to conduct extensive research and consider consulting with a financial advisor before engaging in either spread betting or options trading.

Conclusion

In this comprehensive comparison between options and spread betting, we've unravelled the essentials of each investment method, highlighting its unique characteristics and potential benefits.

Spread betting offers a tax-efficient way to speculate on market movements without owning the underlying assets, making it attractive for those seeking leveraged positions.

On the other hand, options trading provides a structured investment approach, with the advantage of limiting risk to the premium paid, appealing to investors who prefer strategic flexibility.

The key differences between these two investment strategies lie in their approach to market speculation, risk management, and potential returns.

While spread betting is favoured for its tax benefits and broad market access, options trading is renowned for its strategic depth and risk containment.

Ultimately, the choice between options and spread betting should align with your investment goals, risk appetite, and market expertise.

If you aim to make your trading more tax-efficient, a markets.com spread betting account might be the ideal choice for you.

“When considering CFDs for trading and price predictions, remember that trading CFDs involves a significant degree of risk and could result in capital loss. Past performance is not indicative of any future results. This information is provided for informative purposes only and should not be construed to be investment advice.”