Overview of Margins in Financial Spread Betting

Financial spread betting is a derivative product meaning that any prices quoted are derived from the underlying financial instrument. The margin is the deposit required in an account to cover any adverse movement in the position that you hold but because it is a derivative product the margin cover, as it name implies, is only required to be part of the total risk. It is this quality of only having to cover part of the risk that makes financial spread betting a leveraged product.

Most spread betting companies will calculate the margin required to open a trade as:

A margin factor multiplied by the stake per point

The deposit factor is determined by the spread betting provider and is by no means necessarily the same across all providers. This concept margin is more easily explained with an example.

If you buy 1000 shares in Vodafone at 160p your total investment is £1600 - your total downside risk is therfore also £1600 i.e. if the price dropped to zero pence you would lose this amount.

If you are spreadbetting, to get this same exposure you would be required to place a Buy Bet at £10 per point. In other words if you placed a £10 Buy Bet and the price dropped 160 points to zero you would lose £1600.

In order to open a position a spread betting company will calculate an initial margin requirement (IMR) to open this trade. If the margin factor is 5% then:

IMR = 5% x £1600 = £80.

This means that £80 of your account balance will be reserved as margin against this trade. So if a trader's stood at, say, £1000. He would only now have £920 of available margin to open further bets.

It is also worth noting that some spread betting companies will also often require that only up to 80% of an account can be used as margin requirements. So in this case if the trader opened 10 similar bets (IMR = £800) then he would be restricted from opening a 9th as this breaches the 80% limit. A worse case scenario might be that the broker closes all the positions!

This last point helps demonstrate the fact that spread betting companies do not operate their margin policies or factoring calculations in the same way as one another, so it is important to check the literature that the company provides to understand how they implement this.

Margin Factors

In brief, margin factors are calculated on the basis of the price volatility of the underlying instrument. A margin factor on a blue chip share can therefore be expected to be less than that applying to Gold for instance. A lower margin factor indicates a lower risk.

Maintenance Margin

Maintenance margin is the term used to ensure that there is always enough in a trading account to fund the present positions. Hence if a trader takes a heavy loss in one position the funds remaining in the trading account must be sufficient to coevr the total marging requirements of any other existing positions. If this is not the case the spread betting company may make a margin call for additional funds or even automatically close the outstanding positions.

Using stop Losses to Reduce Opening Margin Requirements

The use of stop losses not only limits the potential damage to a trading account but will also reduce the amount of initial margin requirement. This is exactly because the IMR is designed to partially cover the risk exposure of a position and by using a stop loss you are reducing that exposure.

If we take the Vodafone example above again if a stop loss was placed at 100p then the potential loss would only be £600 ([160-100] x £10). This would mean that the IMR would reduce to:

IMR = 5% x £600 = £30

Be aware of your margin requirements

Margin is there as a protection to both the spread betting provider and to the trader. It is important that it is monitored as part of the trading routine. If a trader gets a margin call (i.e. a request to top up your account to meet the margin requirements) he has not been operating sensibly.