The general purpose of spread betting is to create an active market for both sides of a binary wager, even if the outcome of an event may appear a priori (prima facie) to be biased towards one side or the other. In a sporting event a strong team may be matched up against a historically weaker team; almost every game will have a favorite and an underdog. If the wager is simply "Will the favorite win?", more bets are likely to be made for the favorite, possibly to such an extent that there would be very few betters willing to take the underdog.
The point spread is essentially a handicap towards the underdog. The wager becomes "Will the favorite win by more than the point spread?" The point spread can be moved to any level to create an equal number of participants on each side of the wager. This allows a bookmaker to make a market by accepting wagers on both sides of the spread. The bookmaker charges a commission, or vigorish, and acts as the counterparty for each participant. As long as the total amount wagered on each side is roughly equal, the bookmaker is unconcerned with the actual outcome; profits instead come from the commissions.
Because the spread is intended to create an equal number of wagers on either side, the implied probability is 50% for both sides of the wager. In order to profit, the bookmaker must pay one side (or both sides) less than this notional amount. In practice, spreads may be perceived as slightly favoring one side, and bookmakers will often revise their odds in order to manage their event risk.
Spreads in sports wagering
Spread betting was invented by Charles K. McNeil, a mathematics teacher from Connecticut who became a bookmaker in Chicago in the 1940s. The idea became popular in the United Kingdom in the 1980s. In North America, the gambler usually wagers that the difference between the scores of two teams will be less than or greater than the value specified by the bookmaker. An example:
* The bookmaker advertises a spread of 4 points in a certain game;
* If the gambler bets on the "underdog", he is said to take the points and will win if the underdog's score plus the spread is greater than the favorite's score.
* The eventual score is Underdog 8, Favorite 10: 8 + 4 > 10, so the gambler wins;
* The eventual score is Underdog 8, Favorite 13: 8 + 4 < 13, so the gambler loses.
* If the gambler bets on the "favorite", he gives the points and will win if the favorite's score minus the spread is greater than the underdog's score:
* The eventual score is Underdog 5, Favorite 10: 10 - 4 > 5, so the gambler wins;
* The eventual score is Underdog 8, Favorite 10: 10 - 4 < 8, so the gambler loses.
Spreads are frequently, though not always, specified in half-point fractions to eliminate the possibility of a tie, known as a push. In the event of a push, the game is considered no action, and no money is won or lost. However, this is not a desirable outcome for the sports book, as they are forced to refund every bet, and although both the book and its bettors will be even, if the cost of overhead is taken into account, the book has actually lost money by taking bets on the event. Sports books are generally permitted to state "ties win" or "ties lose" to avoid the necessity of refunding every bet.
A teaser is a bet that alters the spread in the gambler's favor by a predetermined margin – in American football the teaser margin is often six points. For example, if the line is 3.5 points and the bettor wants to place a teaser bet on the underdog, he takes 9.5 points instead; a teaser bet on the favorite would mean that the gambler takes 2.5 points instead of having to give the 3.5. In return for the additional points, the payout if the gambler wins is less than even money. At some establishments, the "reverse teaser" also exists, which alters the spread against the gambler, who gets paid at more than evens if the bet wins.
Bets on the total (over/under)
In addition to the spread bet, a very common "side bet" on an event will be the total (commonly called the over/under or O/U) bet. This is a bet on the total number of points scored by both teams. Suppose the Cowboys are playing the Giants and the total is set at 44.5 points. If the final score is Cowboys 24, Giants 17, the total is 41 and bettors who took the under will win. If the final score is Cowboys 30, Giants 31, the total is 61 and bettors who took the over will win. The total is popular because it allows gamblers to bet on their overall perception of the game (e.g., a high-scoring offensive show or a defensive battle) without needing to pick the actual winner.
In the UK, these bets are sometimes called spread bets, but rather than a simple win/loss, the bet pays more or less depending on how far from the spread the final result is.
Example: In a football match the bookmaker believes that 12 or 13 corners will occur, thus the spread will be set at 12-13.
* A gambler believes that there will be more than 13 corners, and "buys" at £25 a point at 13.
* If the number of corners is 16, the gambler wins (16 - 13) = 3 x £25.
* If the number of corners is 10, the gambler loses (13 - 10) = 3 x £25.
* A "sell" transaction is similar except that it is made against the bottom value of the spread.
* Often "live pricing" will change the spread during the course of an event, allowing a profit to be increased or a loss minimized.
In North American sports betting many of these wagers would be classified as over-under (or, more commonly today, total) bets rather than spread bets. However, these are for one side or another of a total only, and do not increase the amount won or lost as the actual moves away from the bookmaker's prediction. Instead, over-under or total bets are handled much like point-spread bets on a team, with the usual 10/11 (4.55%) commission applied. Many Nevada sports books will allow these bets to be used in parlays, just like team point spread bets, making it possible to bet, for instance, "the Packers and the over", and be paid if both the Packers "cover" the point spread and the total score is higher than the book's prediction. (Such parlays usually pay off at odds of 13:5 with no "vig", just as a standard two-team parlay would.)
Mathematics of spread betting
The mathematical analysis of spreads and spread betting is a large and growing subject. For example, sports that have simple 1-point scoring systems (e.g., baseball, hockey, and soccer) may be analysed using Poisson and Skellam statistics.
Financial spread betting
By far the largest part of the official market in the UK concerns financial instruments; the leading spread-betting companies make most of their revenues from financial markets, their sports operations being much less significant. Financial spread betting in the United Kingdom closely resembles the futures and options markets, the major differences being
* the "charge" occurs through a wider bid-offer spread;
* spread betting has a different tax regime compared with securities and futures exchanges (see below);
* spread betting is more flexible since it is not limited to exchange hours or definitions, can create new instruments relatively easily (e.g. individual stock futures), and may have guaranteed stop losses (see below); and
* the trading is off-exchange, with the contract existing directly between the market-making company and the client, rather than exchange-cleared, and is thus subject to a lower level of regulation although the spread betting companies themselves are some of the most regulated entities in the City of London.
Financial spread betting is a way to speculate on financial markets in the same way as trading a number of derivatives. In particular the financial derivative Contract for difference (CFD) which in many ways mirrors the spread bet. In fact a number of Financial derivate trading companies offer both financial spread bets and CFDs in parallel using the same trading platform.
Unlike fixed-odds betting, the amount won or lost can be unlimited as there is no single stake to limit any loss. However, it is usually possible to negotiate limits with the bookmaker:
* A "stop loss" or "stop" will automatically close the bet if the spread moves against the gambler by a specified amount.
* A "stop win", "limit" or "take profit" will close the bet when the spread moves in a gambler's favor by a specified amount.
Spread betting has moved outside the ambit of sport and financial markets (that is, those dealing solely with share, bonds and derivatives), to cover a wide range of markets, such as house prices.
In a falling stockmarket, financial spread betting can also be used by investors as a means of hedging against predicted losses in a portfolio of shares.
In the UK and some other European countries the profit from spread betting is free from tax. The UK and some other European countries tax authorities designate financial spread betting as gambling and not investing, meaning it is free from capital gains tax and stamp tax, despite the fact that its regulated as a financial product by the Financial Services Authority in the UK. Most traders are also not liable for Income Tax unless they rely solely on their profits from financial spread betting to support themselves. The popularity of financial spread betting in the UK and some other European countries, compared to trading other speculative financial instruments such as CFDs and futures is partly due to this tax advantage. However, this also means any losses cannot be offset against future earnings for tax calculations.
Conversely, in most other countries financial spread betting income is considered taxable. For example the Australian Tax Office issued a decision in March 2010 saying "Yes, the gains from financial spread betting are assessable income under section 6-5 or section 15-15 of the ITAA 1997". Similarly, any losses on the spread betting contracts are deductible. This has resulted in a much lower interest in financial spread betting in those countries.
Financial spread bet example
Suppose Lloyds TSB is trading on the market at 410p bid, and 411p offer. A spread-betting company is also offering 410-411p. We use cash bets with no definite expiry, or "rolling daily bets" as they are referred to by the spread betting companies.
If I think the share price is going to go up, I might bet £10 a point (i.e., £10 per penny the shares moves) at 411p. We use the offer price since I am "buying" the share (betting on its increase). Note that my total loss (if LloydsTSB went to 0p) could be up to £4110, so this is as risky as buying 1000 of the shares normally.
If a bet goes overnight, the bettor is charged a financing cost (or receives it, if the bettor is shorting the stock). This might be set at LIBOR + a certain percentage, usually around 2/3%.
Thus, in the example, if Lloyds TSB are trading at 411p, then for every day I keep the bet open I am charged [taking finance cost to be 7%] ((411p x 10) * 7% / 365 ) = £0.78821 (or 78.8p)
On top of this, the bettor needs an amount (AKA collateral) in the spread-betting account to cover potential losses. Usually this is either 5 or 10% of the total exposure you are taking on but can go up to 100% on illiquid stocks. In this case £4110 * 0.1 or 0.05 = £411.00 or £ 205.50
If at the end of the bet Lloyds TSB traded at 400-401p, I need to cover that £4110 - £400*10 (£4000) = £110 difference by putting extra deposit (or collateral) into the account.
The bettor will usually receive all dividends and other corporate adjustments in the financing charge each night. For example, suppose Lloyds TSB goes ex-dividend with dividend of 23.5p. The bettor will receive that amount. The exact amount received varies depending on the rules and policies of the spread betting company, and the taxes that are normally charged in the home tax country of the shares.
Dangers of financial spread betting
According to an article in The Times dated 10 April 2009 approximately 30,000 spread bet accounts were opened last year, and that the largest study of gambling in the UK on behalf of the Gambling Commission found that serious problems developed in almost 15% of spread betters compared to 1% of other gambling. In addition a report from Cass Business School found that only 1 in 5 punters ends up a winner. As noted in the report, this corresponds to the same ratio of successful punters in regular trading.