Yes, some brokers will let you lodge liquid shares, bonds or funds as collateral for CFD trading or financial spread betting if you have a professional trading account. However, should you? In general, I like to be positive about spread betting. We’ve often said it is one of the greatest innovations to happen for private clients in the investment world for some time. But there are only a few occasion when you should use long term investments as collateral for short-term trading.
There is a big difference between investing and trading. The two are not really compatible unless spread betting or CFDs are beings used to hedge an investment portfolio.
There is no doubt that long-term investors generally make money and short-term speculators lose it.
In fact, there has never been a period of more than twelve years when an investor would have failed to make money by doing nothing holding index trackers. In the twenty years I been involved in trading, the only speculators that I’ve seen actually make money are market professionals and hedgers, or ones that trade events rather than charts.
One of the issues here is that spread betting and CFDs are for fun money. It’s for people that want to take high-risk bets for the chance of making highly leveraged profits. Spread betting is a margin product and like all big gambles, CFDs traders should know what they are getting themselves in for. High reward equals high risk.
The profile of the ideal client for CFD or spread betting brokers is someone who has a net worth excluding principal residence of £100k. Has around £90k in long term investments such as bonds, funds, dividend-paying FTSE 100 stocks and trackers. Then £10k of this is in high-risk self-directed investments such as small-cap shares and leveraged products like spread bets and CFDs.
The worst case here is that the client’s £90k will continue over the years to grow in line with the rest of the investment markets. Some ups and some downs but will generate a significant rate of return over the years.
But what happens when all of a sudden, that customer is tempted to use that £90k as collateral against his high-risk investments? All of sudden, his initial margin has risen from £10k or £100k exposure to almost £1m in potential exposure. If the collateral lodged is of sufficient quality and gets a haircut of only 95% then a 10x move in the market, index, currency (or what he trades) could totally wipe out the entire portfolio.
There is a reason, why brokers segregate retail and professional clients and collateral has traditionally only been used by institutional investors. Obviously, if the client has a high-risk portfolio, then the haircut will be higher so the potential exposure will be lower as per the risk profile. But it’s still a tricky little situation.
Overall shares should only be used for collateral if you are a professional client and hedging a position.