Some of these investments, such as Exchange Traded Funds provide cheap ways for novice investors to get access to the moves in a specific stock market index or sector. Others, such as spread betting and Contracts for Difference, can give you the ability to make money when share prices fall and, perhaps, double up your exposure to the gain in a particular share’s value.
This does, however, make some of these investments more suitable for experienced investors so you should tread carefully and make sure you understand the risks you are taking before you invest.
Exchange Traded Funds
Covered Warrants
Spread Betting
Contracts for Difference
Exchange Traded Funds (ETFs) work like index tracker funds, giving you access to the performance of specific indices such as the FTSE 100 or sectors, such as technology. But unlike index tracker funds, ETFs are set up as companies and rather than using computer modelling to track an index, they build portfolios of real shares.
While there should be very little difference between the performance of index tracker funds and ETFs, being set up as companies gives ETFs a real advantage – they can be traded throughout the day like ordinary shares. Index trackers can only be bought and sold at a price set at the end of the day.
The annual fees on ETFs are similar to tracker funds, but you will also have to pay stockbrokers’ commission.
Covered warrants are a recent addition to the range of stock market related investments you can buy. These products give you the ability to profit from a fall in the value of a company’s shares, as well as a rise.
Covered warrants are a relatively new, rapidly growing market that give investors the opportunity to gain exposure to other instruments that are not normally available on the stock market.
Covered warrants, which can be bought for as little as £50, do this by giving you the right, but not the obligation, to buy or sell a share at a specific price and at a specific time. You could, for example, take the view that a company’s share was going to fall in price over the next six months and make money if they did. This is known as ‘shorting’ a share. You are free to sell the warrants you have bought at any time through a stockbroker, just like ordinary shares.
Covered warrants, which are issued by investment banks, can be used as an insurance policy as well as for betting on share price falls. If, for example, you hold ordinary shares in a company you are hoping the shares will go up in value. But you could hedge your bets by buying a warrant that would pay out if its share price fell.
You can also use them to take bigger bets on the market. When you buy shares in a company, the amount you gain is limited to the rise in the share price: if it rises by 20%, you make 20%. But if, for example, you believe a share is set to bounce, you could buy a covered warrant that gives you ten times its gain. So, if the share were to rise 20%, your investment would rise 200%.
If you want to make money from falling share prices or take bigger bets on the market than you can by buying ordinary shares, another option is to spread bet. Spread betting is quite simple and cheap. You can open an account with a financial spread betting firm who will give you a price on a specific share or perhaps a stock market index on a given date in the future. If you think the price will be lower you ‘sell’ at that price and decide how much you want to bet for each 1p drop in the price.
Say, for example, shares in ABC Ltd are trading at between 656p and 658p today. You call a spread better and ask for a price for those shares in November and they quote you 659p to 668p. You think the shares will fall further than that and so you sell, taking a £20 per point fall at 659p.
By November, ABC Bank’s shares have dropped to 640p – a fall of 19p. As your bet was for £20 for each 1p fall, you make £380. All your profits are free from UK capital gains and income tax.
Alternatively, you can take a limited risk bet which allows you to cap your losses without affecting your ability to make money. You could, for example, decide that the most you are prepared to lose if £100. If, in our example, shares in ABC Bank rose, you would not lose more than £100. But you don’t lose any of the gain if they fall.
A Contract for Difference (CFD) is an agreement between two people to settle at the close of their contract the difference between the opening and closing price of a company’s share price. Say, for example, you agree to sell 5,000 XYZ Ltd shares at £10 (£50,000) and the price moves to £8, you make a profit of £2 a share - £20,000.
This example makes CFDs look very similar to covered warrants or spread betting. But the big difference with CFDs is you can gear up your bet, effectively borrowing money to increase your exposure to a share price gain or fall. This means you will make more money if you are right but increase your chances of making horrendous losses if you are wrong.
For this reason CFD trading is really for the experienced investor. In fact many CFD brokers will only accept people who have several years’ experience of trading shares or have already been short selling using another method. You might also be asked to lodge a deposit as security, perhaps £10,000.