By Chris Tate

lt;meta http-equiv=CONTENT-TYPE content=text/html; charset=utf-8gt;lt;titlegt;lt;/titlegt;lt;meta name=GENERATOR content=OpenOffice.org 2.0 (Linux)gt;lt;meta name=CREATED content=20060823;19521800gt;lt;meta name=CHANGED content=16010101;0gt; lt;stylegt; lt;! -- @page dimensions: 21cm 29.7cm; margin: 2cm TD P margin-bottom: 0cm P margin-bottom: 0.21cm - lt;/stylegt; The Australian market has always been fertile ground for people who have wished to experiment with the launching of new derivative products. However, a lot of them have been less than stellar in there penetration of this market, few have found acceptance amongst traders. The derivatives market has witnessed going and the coming of share ratio's, the limpness of talk futures along with the failure currency and index warrants to ch both hearts or pockets of traders. Recent times have witnessed the introduction into the market of spread betting on financial instruments. A phenomenon spread betting has quickly spread to cover many financial instruments and had its roots in sport. Within the context of this domestic market spread betting is provided by IG Index (http://www.igindex.com.au/) Groups such as IG Index offer spread betting over currencies, indices, commodities and interest rate tools. It is even possible to wager on a recession in the housing market via the UK National House Price Survey. You can even bet on the shift in home prices across areas that are varying. Trade Example The structure of a spread bet is straightforward and can best be explained with reference to an illuion. Assume that we consider that in the coming months it will move higher and have a positive view on BHP. We've got a selection of tools that will make it possible for you to trade this perspective and we opt to utilize a tool. The price quotations for spread bets are similar in theme to the quotes for other derivatives. You've got a streak of months, which have different bid/offer quotes. As you would expect the quotes together with the time to expiry possess the cheapest bid/offer spread. The difference in spreads across the various time frames is that a manifestation of holding prices or interest expenses. In this respect a spread bet is similar to an option or futures contract at which the price of carrying out a position is represented in the pricing. In case the share were to pay a dividend in this interval then the prices would reflect this cash based trade. It is very important to mention that the prices do not reflect any bias by the quote provider, they're calculated mechanically in the same way futures prices are calculated. In this example assume that we desired to take a position so that we opt for the June wager. The point we need to decide is the amount of our wager, contrary to other derivatives which have a dollar value for every tick a spread wager lets you place your dollar weighting. And as we will see this choice is essential to the management of this transaction.

Imagine that we decide to risk $50 each stage. We have decide to buy June BHP at $50.00 per stage, meaning that for every stage BHP moves we either make or lose $50.00. Based upon these prices we control $63,656 value of BHP ($50.00 per point x $1273.12).

As with other derivatives once we engage this position we are charged a margin. This margin reflects our wager dimensions multiplied by a deposit factor that it place by IG Index. The deposit points for all instruments can be found in their Product Disclosure documents.

Assume that our view was shown to be correct and in the upcoming month BHP moves up and we opt to sell our BHP in the prevailing bid price of 1452.26. Our sale profits are 72,613 ($50.00 per point x 1452.26), this gives us a entire profit on the transaction of $8,957.

However it's always important to consider the worse case scenario of BHP suffering a powerful reversal. If BHP had fell to 1150.00 and we chose to reduce our losses we would have lost $6,156 on the trade.

This highlights the need for caution when dealing with any leverage instrument. The tendency of traders when they enter a leverage market is to take on as much risk as they can possibly finance. This is far too much risk and doesn't reflect trade management.

Position Sizing

Take our earlier example of BHP, this example showed how quickly losses could collect with a massive bet size. As mentioned earlier there is an inclination among traders to utilize all of of the leverage and consequently suffer from a reduction. Since we can establish how big our wager we need a mechanism of determining the bet dimensions for our risk profile.

That is quite a easy endevour and is founded upon our risk amount and the distance to our first stop. For example assume that our first risk is $1,000 and that we are utilizing a 2 ATR stop valued at $0.45 or 45 points, you have to keep in mind that bets are defined as points.

Based upon these figures our appropriate bet size is 1,000/45 = 22.22, Since we can simply wager in round numbers we round this down to $22.00. Thus, if our situation was supposed to drop 45 points and we had wager $22.00 then our maximum loss would be $990 ($22 x 45 points = $990), marginally lower than our estimated $1,000 because of our rounding down.

When we had a wider stop we would have experienced a decrease wager size. If for example we were setting our wager size based upon a specialized feature that was 65 points off our wager size would be 15.38 or $15.00 rounded down ($1,000/65 = $15.38)

Placing a smaller bet dimensions gives the position room to maneuver and allows the transaction to grow. You may see that the size of the wager and the degree of your risk are intertwined. If within our first BHP example we had a first risk of $1,000 plus a bet size of $50 then BHP would only have had to maneuver 20 points or $0.20 to activate our stop. When you consider that in the time of writing that the ATR(15) of BHP was 20.10, unless we were extraordinarily gifted in our time of our entry or more likely quite lucky our odds of surviving more than 1 day are extremely reduced. Because you can see ego based bet sizing is extremely pricey, it more wise to base the wager sizing on some kind of risk assessment rather than that which you think that you can tolerate.

We can back up this original form of risk management using a controlled risk stop. The controlled risk guarantees that no matter the market activity on the day your stop is triggered the loss you will suffer is that defined by your stop. By way of example if we had a position in AMP in 700 and also a controlled risk stop set at 600 and the market opened at 500. Our stopped would be triggered and honoured at 600, so our loss is limited to our predetermined figure.

The ability to establish a guaranteed stop is just one of the major advantages that the new firms providing spread betting and CFD trading have introduced in Australia. Overnight we've gone from a situation where brokers are reluctant to handle stops and traders are more reluctant to take stops where positions can not be opened without a stop in place, when they occur; to a situation. This stop is then honoured by the supplier no matter the market price.

Naturally the spread betting firm charges a margin with this facility but when compared to the slippage that can be encountered in highly leverage positions the price tag is rather small.

Comparison

The matter needs to be asked under what conditions would you use a spread betting tool instead of simply going long the inherent or using an exchange traded option.

To answer this question you first have to know about both your motivations for trading along with your own experience. Often traders try and answer this question simply by asking which one is going to make me the cash. This regrettably in one of those nebulous.

My feeling is that traders should not dabble in derivatives until they've had some experience at trading the underlying instrument. Trading the inherent will enable you to fine-tune your egy and your plogy within an environment that lacks much of this death nature of derivative trading.

If you are at some time on your trading career where you feel confident using derivative's then we need to break down the pro's and con's of spread betting versus additional derivatives. The main competitor are options, we can dismiss share futures that are single as they're simply a non-event.

ETO Benefits Can trade time and volatility, you may also set in play egies that enable you to trade range bound stocks. You are not limited to plays.
Well accepted, ETO's have a long history in Australia.
Strong standardisation.
Can deal with a number of providers, you may also exit a situation by dealing with another trader rather than dealing with precisely the same market maker.
ETO Disadvantages Liquidity in positions that are individual may be a problem.
On-line platforms , this indies that you might have to talk to a broker. Whilst this might not seem terribly onerous it does introduce problems for people who have brokers that are keen to provide guie.
The setting of stops is extremely problematic with most brokers unwilling to take care of stops. This may result in an open ended liability with written positions.
Dealing with market makers may be an interesting experience.
To the retail client it can seem as if the spreads comprise on the place by the market maker.
Whilst there are a few 50 shares which have ETO's in fact trading Is restricted to around 10 stocks, 4 of which are banks so the range of stocks is quite poor.
Spread Betting Benefits Available on a wide range of markets covering equities, indices, commodities and interest rate vehicles.
Can set level of gearing, there's absolutely no fixed tick weighting that might preclude traders from trading derivatives such as futures contracts.
Stops are mandatory in regulated risk accounts and are guaranteed.
Strong liquidity; transparent quotes so you are able to take a look at the price you see on the screen. There's no requirement to pursue the market manufacturer around attempting to have filled.
Mature online platform allowing the dealing in a variety of tools from a single platform.
Spread Betting Disadvantages New to the Australian market.
The possibility to set your level of gearing will cause problems for undisciplined traders.
You do have to deal with a single party. You can't start a trade and then arrange to shut it with another.
I feel spread betting's most interesting quality is that it is a derivative that appears to be gaining acceptance. If the experience in the united kingdom is a manual then items such as spread betting and CFD's are likely to gain a foothold in the local market. This is a significant figure when you think that turnover is quantified in commission or spread not the dollar value of transactions