Outlined below are the main disadvantages and risks of Spread Trading over traditional share investments:
No Dividends
As traders never take ownership of the actual shares they trade they therefore are not entitled to any dividend payments which may be due to shareholders. Some shares don’t pay a dividend but others can pay a dividend which can be up to 10% or higher per year.
No Voting Rights
Similar to not qualifying for dividend payments, likewise spread traders are not entitled to attend the AGM of companies which they spread trade and have no voting rights at these meetings.
You can’t offset loses against Tax
If you purchase and own shares (as opposed to spread trading) and you end up making a loss on your shareholding when you sell them, under current Irish tax law you are entitled to right that loss off against other income, thus reducing your overall tax liability. When you spread trade, because it is a bet rather than an investment, you cannot offset any losses incurred against other income. While there are benefits in being able to offset losses incurred against your tax liability when you purchase shares, it could be argued that one’s goal when investing should not be to incur losses in the first place!
You can lose more than your Initial Investment
By far and away the biggest risk associated with Spread Trading is the fact that you can lose more than your initial investment. With traditional share purchases, the most you can lose is the money you spent on those shares (which only happen if the shares went to zero).
With Spread Trading however, you can lose more then your initial investment. Lets take our CRH example again, you decide to Buy (go Long) CRH at €17.00 per share (1700) at a stake of €10 per tick. At an IMR of 15% the amount of money you need to have in your spread trading account to complete this trade would be €2550. Now lets take a scenario where CRH announce a profit warning or some other news that the market does not like and CRH’s share price opens up much lower, say at €10.00 per share (1000). In this case your spread trade on CRH would now show you down €7,000 (700 ticks at €10 per tick). In an absolute worse case scenario lets say CRH went to zero, you would then be down €17,000. While this may seem an unlikely scenario it can happen, think of recent examples such as AIG, Anglo Irish Bank, Northern Rock, Nortel Networks to name a few which highlight that the risks involved in spread trading can be very high.
Stocks can Gap Lower or Higher than your Stop Loss
Related to the previous point is the fact that just because you have a Stop Loss in place that does not guarantee that your losses will be limited to the amount of your stop loss. A stop loss is an automatic order to close out your position if the price its a certain level you set. Stop losses are an excellent idea and should always be used. However it is important to remember that sometimes prices can gap up or down based on specific share news or just as part of the general market sentiment. If the market gaps to a price beyond your stop loss your spread trading company will attempt to close your position at the best price they can get on the market. This can result in you losing more money on the trade than you had originally budgeted for when you set your stop loss.
