Can I be sure SB company will pay up if market crashes?

[suchong]

I am considering buying shares and may hedge them for lengthy periods of time by shorting the FTSE via a spread betting company.

But if there’s a major crash (eg. Suppose a war / natural disaster wipes 20% or more off markets overnight), can I be absolutely certain that the spread company will pay up? Could they lose out in a crash in two ways:

a) Entities with whom they have have hedged short bets may be unable to meet their obligations.
b) Punters leveraged to the long side may be unable to pay up.

Might either of the above cause the spread company itself to go bust or withhold funds? If so, is there any other way of shorting the market with a certainty of getting paid?

 

[shadowninja]

b) Punters leveraged to the long side may be unable to pay up.

A punter has to deposit enough to cover a bet in my experience (IG and Tradindex).

 

[grantx]

Suchong,

No point in hedging your stock positions via shorting the FSTE unless your holdings reflect the underlying stocks of the FTSE, ie weightings and composition. If not, you will be overpaying (even more so via SB's), over-hedged on the downside, and possibly over-exposed on the upside on the short position. However, even assuming everything does match up, then the net effect would be a neutral position or zero exposure, ie what you gain on your stocks, you lose on the short.

You may be better looking at equity options - buying puts or selling calls - against your holdings. This will provide degrees of protection with upside exposure.

Use an FSA authorised broker, not a bookie.

Grant.

 

[suchong]

No point in hedging your stock positions via shorting the FSTE unless your holdings reflect the underlying stocks of the FTSE.

Here is why I asked: I’d rather not invest in property or the stockmarket at the moment, so will be staying in cash.

But I pay 40% tax on income. However, perhaps I could effectively keep money in cash while paying tax at the new 18% capital gains rate and 32% dividend rate, by buying a FTSE tracker and shorting the market via a spread bet.

My calculations suggest that an investment of £100k would gain between about £0 and £13k over a 10-year period compared with cash, depending on stockmarket performance (over a number of years – wouldn’t make sense to do it for 1 year because if the market rose, I’d have to pay 18% tax on the gains but would get no tax relief on the SB loss. However, over multiple years, excess returns over cash can compound so that I’m ahead even after the 18% is paid).
One of the outcomes that would give an extra 1% per year versus cash, is if the market remains flat or falls. eg. SB company predicts FTSE will rise 3% per year. If I buy shares, then I collect the 3.2% dividend (32% tax payable), but in addition collect a tax free 3% from the SB company.

But whether I should even consider this option depends on whether I could be absolutely certain that in the event of a major crash, who ever I hedge my position with would pay up. Could I be certain enough?

A punter has to deposit enough to cover a bet in my experience (IG and Tradindex).

The deposit is only enough to cover a small market move. If the market crashed suddenly the SB companies wouldn’t have enough time to determine whether clients could maintain their positions.

 

[anley]

Suchong, what you're proposing looks very complicated, I wouldn't try it. And yes, it's very possible for a SB company not to pay up if the markets get nasty.

Why not talk to a very good tax-accountant, he'll surely be able to help you in some ways.

 

[Jack o'Clubs]

As others have said, I'd be very wary at using s'bets as your hedge. Download a few T&Cs - Iif I remember correctly from those that I've read, they have the option of scratching a trade/position in the event of a black-swan type occurance. Also keep an eye on how they calculate financing charges on their short-positions - you might find the finance on the leverage portion quickly erodes the few-percent you're hoping to make from the FTSE dividend yield. If you're after low risk, low return type hedging strategies then it might be worth looking at covered-call strategies. You only get limited downside protection though.

By the way - are you sure that the average FTSE tracker fund pays out its components' dividend? I thought it was one of their little swizzes that you get the performance relative to the cash index level, but they keep the dividend for themselves...

And ultimately - if all you are after is the FTSE dividend yield, and you're hedging out any capital gain, aren't you much better off with the money in a high-interest savings account - you should be able to get a net rate of nearly 4% even as a 40% tax payer.

 

[shadowninja]

The deposit is only enough to cover a small market move. If the market crashed suddenly the SB companies wouldn’t have enough time to determine whether clients could maintain their positions.

As an example, IG Index have guaranteed stops which means once you pass a certain point, you're out. Slippage irrelevant. Tradindex have a margin reserve that you have to pay (which I assume accounts for slippage) as they don't offer a guaranteed stop system.

 

[the blades]

Suchong,

I've done what you're suggesting for years. I don't really agree with Grant - you aren't neutral as such - you will profit or lose depending on the out (or under) performance of your portfolio against the FTSE, or whatever you hedge against.

My prime concern has always been protecting against a market crash - in theory corrlations fo shares should increase and they all fall together, in practice......

I shared the same concern as yourself and after advice from JO'C (above), and being blinded by science by Grant (he's a clever chap), I've moved to futures to hedge my portfolio. It's also better from a tax perspective, as long term the index will rise and you can offset your gains, tax wise.

The negative is that many portfolio's aren't large enough to balance easily with futures contracts - so I still have a little bet on to balance the whole thing up.

Cheers,
UTB

 

[grantx]

UTB,

Thank you for the compliment. And you are a Gentleman. Suchong is obviously a closet Yorkshireman.

Suchong,

Re JOC’s point. I’m 99% certain trackers don’t pay dividends (I think they’re essentially synthetic futures). And there may also be redemption penalties.

Bear in mind that the greater risk you remove from your portfolio, then theoretically the return will more closely approximate the risk-free rate of return. However, this excludes all costs – commissions, spreads, interest charges, stamp duty, ptm levy (is that still around?), etc.

Your looking to a do a lot to maximise very little. The best solution would be to stick it in a tracker – all-or-nothing (all the upside, none of the downside).

I doubt central bank bail-outs can be taken for granted. Remember Barings.

Grant.

 

[Profitaker]

Download a few T&Cs - Iif I remember correctly from those that I've read, they have the option of scratching a trade/position in the event of a black-swan type occurance.

That is both frightening and very difficult to believe that anybody would do business with them if it were true. Just had a quick scan of IG's T & C's and can find nothing. Also, IG are regulated by the FSA with regards to any business in the financial markets.

Anybody else got an angle on this ?

 

[shadowninja]

AFAIK, the only exception with IG is that binaries are not covered by the FSA.

 

[Jack o'Clubs]

That is both frightening and very difficult to believe that anybody would do business with them if it were true. Just had a quick scan of IG's T & C's and can find nothing. Also, IG are regulated by the FSA with regards to any business in the financial markets.

Anybody else got an angle on this ?

Section 22 of IG's T&Cs on Force Majeur seems pretty specific. Sure, we're talking about major events here, but the fact is when Iran launches its missiles at Israel, I'd want better cover than that implied by parts 2b) and c) here:

22. Force Majeure Events​

(1)

We may, in our reasonable opinion, determine that an emergency or an

exceptional market condition exists (a “Force Majeure Event”), in which case we
will, in due course, inform the FSA and take reasonable steps to inform you. A Force
Majeure Event will include, but is not limited to, the following:
(a) ​

​

any act, event or occurrence (including, without limitation, any strike, riot or

civil commotion, act of terrorism, war, industrial action, acts and regulations of
any governmental or supra national bodies or authorities) that, in our opinion,
prevents us from maintaining an orderly market in one or more of the Indices in
respect of which we ordinarily accept Bets;
(b) ​

​

the suspension or closure of any market or the abandonment or failure of any

event upon which we base, or to which we in any way relate, our quote, or the
imposition of limits or special or unusual terms on the trading in any such market
or on any such event; or
(c) ​

​

the occurrence of an excessive movement in the level of any of our Indices

and/or any corresponding market or our anticipation (acting reasonably) of the
occurrence of such a movement;
(d) ​

​

any breakdown or failure of transmission, communication or computer

facilities, interruption of power supply, or electronic or communications
equipment failure; or
(e) ​

​

the failure of any relevant supplier, broker, agent or principal of ours,

exchange, clearing house or regulatory or self-regulatory organisation, for any
reason to perform its obligations.
(2) ​

​

If we determine that a Force Majeure Event exists we may at our absolute

discretion without notice and at any time take one or more of the following steps:
(a) ​

​

increase your deposit or margin requirements;

(b) ​

​

close any or all of your open Bets, other than any Controlled Risk Bet, at such

Closing Level as we reasonably believe to be appropriate (and, in the case of a
Controlled Risk Bet, where there is no quotation available, we may close any such
Bet at the time when we reasonably believe that, but for the existence of the
Force Majeure Event, the level set by you for closing the Bet would have been
reached);
(c) ​

​

suspend or modify the application of any or all of the Terms of this Agreement

to the extent that the Force Majeure Event makes it impossible or impractical for
us to comply with the Term or Terms in question; or​

(d) alter the Determination Date for a particular Index.

​

 

[jpu1978]

If you use a big cash rich company like IG, CMC, Barclays etc. there is less of a chance that they will be unable to pay up.

I think most SB companies have good risk management so are unlikely to get caught out with massive exposure in a crash.

 

[Jack o'Clubs]

If you use a big cash rich company like IG, CMC, Barclays etc. there is less of a chance that they will be unable to pay up.

I think most SB companies have good risk management so are unlikely to get caught out with massive exposure in a crash.

sure, but the question is more around big one off events that they wouldn't be able to hedge against (ie a 9/11 or Black Monday).

 

[Profitaker]

J of C

Thanks for looking it up, I must be going blind in my old age !

As far as I can see, if they declare Force Majeure, they can a) increase margin requirements (fair enough) and b) Close any open bets (bit naughty, but could be a blessing in disguise), but I cannot see where it says they could scratch the bet ?

 

[Jack o'Clubs]

J of C

Thanks for looking it up, I must be going blind in my old age !

As far as I can see, if they declare Force Majeure, they can a) increase margin requirements (fair enough) and b) Close any open bets (bit naughty, but could be a blessing in disguise), but I cannot see where it says they could scratch the bet ?

Sorry - by scratch I meant close. But closing the bet would leave the OP's FTSE long pretty exposed (even if we've now established that the lack of dividend on a FTSE tracker makes the whole idea a no-go) given that the idea was to winkle out a few points of risk free return.

 

[Profitaker]

Thanks for clarifying J of C. Yes, it would leave the OP's FTSE long pretty exposed.

 

[grantx]

PT,

I’ve seen this a few times (can’t remember where) – seems standard. Also, they can determine there prices without reference to the underlying.

FSA regulation is irrelevant here; effectively (and legally), these bookies are running an otc book . Therefore, “Conduct of business”, ‘client interest’, ‘best execution’ etc won’t apply or at least would be so flexible as to be meaningless.

Why would anyone want to do business on these terms? Low cost of entry. I don’t buy the tax angle – it hardly compensates.

Grant.

 

[shadowninja]

So if you were shorting FTSE at £50/pt and we had a massive fall in the markets, they could tell you to "sling your hook"?

 

[stevespray]

Interestingly I've raised these points before and indeed carried out a few investigations on my own.

The first thing to stress is that all spreadbets are legally enforcable by law - this is stated in the Financial Markets Act. If a firm tried to cancel a bet then they would be hard pressed to get away with it even if they produced and interpretation of their T&C which appeared to allow them to cancel. You see, nothing in the T&C can conflict with what is stated the Markets Act and, if such a situation arose where there was a conflict, the Markets Act would prevail.

If you read what is posted with regard to the IG contract then you will see that they can not 'cancel' a bet as such. Their right is an entitlement to close a bet. That closure would have to be a prevailing price and not automatically at the level the bet was opened at.

There is 'counterparty risk' in any financial based contract. Whilst the firms set out the NTR's and deposit factors there could clearly be times where these deposits are not enough to cover client losses. Lets say the NTR on FTSE is 100x stake - this means that a particular client could have an account in debit if the FTSE moved more than 100 points against their position. Of course the firms raise and lower these NTR's from time to time but it is unlikely that a suitable NTR would be in place to cover a 'Black Monday' type situation. Likewise for an unpredicted geo-political issue.

So what it all comes down to is how much 'cash in the bank' a particular firm has. This in effect is your security. Even if a firm keeps a reasonably balanced book a great deal of that 'balance' is going to come from other clients betting against you. If those clients can't or won't pay then the firm will be exposed. There is no way around this for the firms. They are relient on clients making good their losses.

On the subject of hedging without remaining constantly exposed - Finspreads offer a G/teed order system which I believe you can use to allow you to open a bet. They take something like 3 x stake when you place the order with them but you can alter the order level once the order is on their system. Maybe I'm missing something here but if you used their "Year End" bets on Dow or FTSE then you could effectively have 'Crash Insurance' for a whole year for 3x a particular stake - seems like good value to me.

Steve.