Overnight Financing Explained: What is it and is it important?

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Overnight financing is what CFD platforms and spread betting brokers charge for holding a position overnight. For long-term derivatives positions, it can add up to a huge amount. In this guide, I will explain what it is and how it is charged.

Spread betting & CFD overnight financing charges explained…

Ever wanted to know how spread betting companies make money through financing charges?

There was an article in City AM a while ago entitled “Everything you need to know about spread-betting charges” that contained zero helpful information about spread betting charges.

So, here we’ll take a quick look at how spread betting companies make money and also how they charge their clients.

There were lots of quotes from brokers which looked like they came off a press packed special provided by a PR company.  What the article failed to do was explain whey spread betting companies charge overnight financing fees.

Firstly, lets clear up how spread betting brokers make their money – there are three ways:

  1. The spread
  2. Overnight financing
  3. Position netting (the b book)

The spread:

Spread betting companies historically made their money by widening the spread of an instrument such as the FTSE.  Say the FTSE was trading 5550 bid 5551 offered they would quote 5545 bid and 5555 offered.  Yes amazingly they were able to quote a ten point spread in the FTSE so if someone was betting £10 per point their profit was £90.  However, due to competition spread are now pretty much inline with the market prices on popular markets. For liquid markets they can be quite wide, but they are still very competitive.  Obviously spread betting companies have had to look elsewhere for their profits.

Overnight financing:

This is what the broker charges you for running your position overnight.  As spread betting is a leveraged product you only have to put down a small deposit to have a lot of exposure.  For example you can buy £10k worth of Vodafone with only £500 down as a deposit.  So essentially the broker is lending you £9,500 for the trade.  There is a cost to this and it is either small or large depending on  your perspective.

If you are the type of person who thinks everything on the internet should be free you will think it is outrageous that they levy this charge on traders.  If you are sensible you will realise that it is in fact a very cost-effective way of trading above your means.  You alternative you are borrowing money from banks credit cards or using cash money that you would have otherwise paid off these debts with to be unleveraged in trading and speculation.

What is amazing about the financing rates is that they have been pretty consistent since the industry started.  they are still around 2.5% – 3% over/under LIBOR or 1 month LIBOR.  With LIBOR being so low it means you are charged 2.5% – 3% on longs.  You are also charge don short because the rate inverts to a minus figure.  If LIBOR was above 3.5% you would receive.

Position Netting

Often referred to the B Book.  This simply means that it is not cost effective to hedge every single small trade that is executed online.  Stock exchanges charge for every transaction that is made.  In some cases spread betting companies will also let clients trade in stake sizes smaller than the underlying market.

For instance, the FTSE 100 future trades in 1 lots.  The size of this 1 lot is equivalent to £10 per point.  If the FTSE is trading at 5550 then the value of 1 contract is £55,500.  So the options for customer are either trade in big size or let the spread betting firms net off your trades against other clients or simply hedge when exposure gets to a certain point.  most brokers are very risk averse now so will only take a limited amount of risk on their clients losing money – even though most do (eventually).

Is overnight financing a bad thing?

No it is not.  You can either borrow money to trade from your bank or your broker.  It is cheaper to borrow it from your broker.  Also, if spread betting firms lost this particular revenue stream then spread would have to be wider.  Or worse still, as the market become more competitive, everyone would go out of business.  That may be good for consolidation, but competition in the industry is what makes British trading platform some of the most intuitive and datacentric in the world.

How important are overnight financing charges for spread betting and CFD accounts?

Pretty important actually, so if you hold positions for a few days or run long-term long/short leveraged portfolios read on…

I remember years ago when I was trying to get my first job as a broker I made a bunch of call back requests to the major brokers and had the sales guys pitch me what spread betting and CFD trading was.

Of course, I knew, as I’d been trading pretty much since school, but I thought it would give me an edge during the interview process. It didn’t because I’m a hopeless salesman…

One broker (who shall remain nameless and is not featured on the Good Broker Guide) said that financing charges are so small that it’s hardly worth considering them in your P&L calculations.

To be fair, he, as a broker probably didn’t really care about them because sales traders get paid on commission splits and don’t (unless they are superb negotiators) get a split of the financing income they bring in.

But financing charges are not small, and this was 15 years ago when they were 3% over/under 1 month LIBOR was around 5%. So on long positions, you’d get charged 8% on the value.

Which means if you have £100k in exposure you’re getting billed £8k per year in overnight financing.

If you are full leveraged on FTSE 100 stocks at 5% margin that’s £3k more than your account balance.

Back then, if you were short you would collect interest payments on short positions, but now that LIBOR is so low you’re actually paying interest on short positions (the broker does have to borrow the stock and there are costs associated with that so it’s reasonable to pass these on to the customer, but it’s worth considering).

Keep in mind that back then commission could be 0.5% (the stamp duty equivalent) as opposed to a fairly standard 0.1% on CFD trading and spread betting spreads.

If you’re following a trade guru with a social trading broker this is particularly relevant as even though you may be running a market neutral portfolio you will be charged overnight financing on the combination of your long and short exposure.

What’s also interesting about financing charges is that whilst the entire industry is in a race to the bottom of commission costs and spread width, financing charges don’t seem to have moved at all.

Most brokers still charge around 2.5% over/under 1 month LIBOR and you’ll have to have a pretty decent account to get them any lower.

It’s just one of those charges that nobody really knows about, or cares about until they add up how much they have been charged. Classic salami tactics.

Brokers who hedge positions have to buy the stock and they have to borrow the money for that from somewhere. They can’t use client funds as they are segregated for retail OTC traders so they are paying to finance the position and adding a markup.

So, if any broker ever tells you that financing charges shouldn’t be included in your P&L they are talking rubbish. Overnight financing is one of the largest costs to trading on leverage. Especially in the crypto markets where spreads and financing are much more expensive than established asset classes.

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