Running your investment portfolio as if it were a hedge fund is not about embracing danger, it's about targeting more consistent returns across market upturns and downturns. But, to do that, you need to be prepared to short the market and, unless you know what you're doing, that's where the danger lies.
Spread betting
If you're new to the idea of shorting, and you want to try your hand, then spread-betting is probably the best place to start.
You can start with just a few pounds and, because it is an entry-level product, most spread-betting companies go to greater lengths to educate first-time customers. Many spread-betting websites - such as finspreads.com, capitalspreads.com and cmcmarkets.com - also offer training academies or virtual trading accounts.
It is always a good idea to familiarise yourself with how to place a trade and how to close it out. When you really need to capture a market opportunity or stop a losing position, you should be able to do so within seconds. Any fumble with your fingers could cost you serious money.
It may seem odd at first, but when you go short, you can actually earn interest on your investment. To understand why, think about how shorting a stock like Vodafone works. A long-standing Vodafone shareholder will agree to lend out its shares for a small fee - it's no skin off their nose because they plan to hold the stake for years.
But you want to sell Vodafone short, so your spread-better borrows the shares on your behalf and promptly sells them. You now have a short position on Vodafone. When you close your position - say, a week later - the spread-better buys back the shares and returns them to the long-term owner. Hopefully, the price you sold at is higher than the price at which you bought back the shares, giving you a profit. Remember, though, that once the shares have been sold, there is money lying around. Or rather, there is money that can be put into an interest-bearing account. And it is not just the size of your bet, but the underlying position.
Suppose, then, you go short of AstraZeneca at £10 a point. That is a pretty hefty bet, similar in exposure to selling 1,000 shares. Since the shares currently trade at around £30 a pop, that short position is worth £30,000 - money that will go into an interest-bearing account for the duration of your trade.
The spread-better will not pass on all of the interest earned on that money. Some of it goes to pay the long-term owner of the shares, some goes to you and the rest goes to the spread-better.
Different spread-betters share out the interest in different ways, but they nearly all use a formula based on the Bank of England's overnight interest rates (a rate called Libor, the London Interbank offered rate). If you get Libor minus 200 basis points - which would work out at 2.75 per cent at the moment - you are getting a good deal.
What's more, all profits from shorting stocks, indices, currencies and commodities are free from capital gains tax (CGT) if you use a spread-better. But you can earn up to £8,800 in capital gains in the current tax year before you start to pay CGT anyway.
If the idea of earning money while you short stocks appeals, remember there is no such thing as a free lunch. One downside of shorting is that you are liable for the dividends if you hold the shares over the ex-dividend date (the cut-off point for shareholders to be eligible for the most recent dividend payment).
To see why, cast your mind back to that long-term shareholder who is lending out his stock, say, Lloyds TSB. When Lloyds pays out a 7 per cent dividend, don't imagine he'll forget that fact. He will want his dividend paid into his account. You, as the shorter, have to pay it if you are shorting the shares when they go ex-dividend.
| SPONSORED LINK |
|---|
| For more detailed examples about how spread betting works and investment other investment information from Barclays Stockbrokers please click here |
Contracts for difference
The terminology used with contracts for difference (CFDs) may vary slightly from spread-bets, but they boil down to much the same thing. When shorting with a spread-bet, you choose how many pounds per point you want to bet on a company to fall. A £2-a-point bet on HBOS to drop from its current level of 930p makes you a net £20 profit if the share falls 10 points to 920p. To do the same with a CFD broker, you would sell two HBOS CFDs.
With both derivatives, your profit of £20 would be subject to charges, fees and spreads. With the spread-bet, the only charge is in the bid-to-offer spread. For example, a spread-better such as IG Index might quote you a price of 929-932. And that 3p spread is where it makes its profits.
However, the bid-offer spread for a CFD in HBOS should be the same as in the underlying market, which may be as narrow as 1,076p-1,076.5p, or 0.5p. You often pay less in spreads when shorting shares with CFDs, but, on the down side, though, you pay a fixed commission of around £10 per trade (or £20 for the round trip of opening and closing a position), or 0.15 per cent for larger trades.
Most, but not all, CFD providers offer a wider range of companies and markets to short than do spread-betters. However, one big disadvantage of shorting with a CFD is that any profits are liable to CGT. That said, if you come a cropper with a trade, you can offset any losses against future capital gains - something that is impossible with spread-bets. If you are trying to follow the mentality of the hedge fund, you expect to make losses, just as you expect to make gains. So being able to net off profits and losses can make a big difference.
Covered warrents
One drawback with spread-betting, CFDs and futures is that if your pessimism proves unfounded, and the stock, index or commodity roars ahead, you can soon be deeply in the red. Stop-losses can help, but they are not guaranteed. Some providers offer guaranteed stop-losses, but they can be expensive and you may not be able to put the stop loss closer than 5 or 10 per cent away. That sort of distance is fine when you own the underlying stock, but, when you trade with financial leverage of 5 or 10 times, a 10 per cent move in the underlying can wipe you out.
Covered warrants offer a less stressful way to short the market. You can never lose more than your initial stake, and yet financial gearing and potential upside are comparable with spread-betting.
Here's how a typical covered warrant trade might work. In order to short, you need to buy a put warrant. For example, say you want to go short of BHP Billiton. SG has a put warrant - ticker SF21 - with a strike price of 900p, expiring in March 2007. When you buy this warrant, you buy the right, but not the obligation, to sell Billiton shares for 900p come 16 March next year.
Ideally for you, between now and then, Billiton's shares will plunge from their current levels of 956p. Should Billiton fall to 800p by then, you would be 100p in the money. Your warrant would be worth 100p because you have an enforceable contract to sell Billiton at 900p a share (a contract that you can fulfil by buying shares at the market price and pocketing the difference).
In effect, though, warrants are cash-settled, meaning that your warrants broker would automatically credit your account with the difference.
If Billiton remains strong - above the strike price of 900p by expiry - then your put warrant will expire worthless.
So how do you value such an option? For a start, you don't. The warrant issuers set the prices using a complex financial model. They decide what sort of volatility to expect from the stock and the overall market, which they input into their models, adding in the time to expiry, the difference between the strike price and the current price, any dividends and prevailing interest rates. The model then spits out a number that you can either accept or reject. The SF21 Billiton put warrant, for example, is priced at 3.57p-3.67p.
To work out how much Billiton has to fall to make you money at expiry, take the warrant's asking price and multiply it by the warrants parity - in this case it is 10, making 36.7p. Then subtract that number from the strike price of 900p, giving you 863.3p - this is how far Billiton has to fall to make you money at expiry. But if you think that the mining sector is about to hit a rocky patch, then even if you don't think it will fall that far, you might want to buy the put warrants.
It doesn't matter that Billiton's current share price of 956p is still a long way from the strike price or the break-even price at expiry. The point is that any sharp drop now improves the prospects of the warrant finishing in the money, and that would be reflected in an immediate rise in the value of the put warrant. Most of the profits made by warrants come from trading in and out in this way, not holding them until expiry, when most warrants expire worthless.
Bear certificates
If you want a simple, hassle-free way to hedge your portfolio against a fall in the market, consider SG's Reverse FTSE 100 Tracker. Also known as a bear certificate, it tracks the FTSE 100 index, but in reverse. So a 1 per cent fall in the index will lead to a 1 per cent rise in the certificate, and vice versa. The tracker has no fixed expiry time, no annual fees, finance charges, running costs and is exempt from stamp duty. And, unlike spread-bets, CFDs or futures, there are no margin calls, meaning that even if you call the market wrong and it goes from strength to strength, you will never be asked to put in more money.
Its level is calculated in a simple transparent way. Start with 10,000 and subtract whatever level the FTSE 100 is trading at - say, 6,050. The reverse tracker's price will be 10,000 minus 6,050, or 3,950, which is then divided by 1,000 to give a price in pounds, namely £3.95. This is also the minimum dealing size. The ticker is S599, and you can buy and sell it throughout the trading day as it trades on the London Stock Exchange. For the same reason, your stockbroker should charge you the same dealing fee for trading the tracker as for a standard share deal.
