I hope that the last few pages have provided a solid introduction to the $tse 100ex, and perhaps given you a different perspective on this complex financial instrument which speculators and traders bet on daily, but few have any deeper understanding of the complexities which lie beneath the figure that we all follow so closely each and every trading day. As I have suggested, in betting on the ftse 100, we need to follow the broader markets and in particular those industrial sectors and associated commodity markets which can and do provide the drivers to equity and stock markets around the world. So having decided that you want to concentrate on $tse bettingyour preferred financial instrument, what are the options for a ftse bet in the market, and how do the prices quoted relate to the FTSE 100 that we have looked at over the past few pages. This unfortunately is where most new traders get very confused, we we now start to enter the more complex world of futures and $utures tradingich is very different from the share markets managed by the major exchanges such as the London Stock Exchange, and perhaps the simplest place to begin is with the LSE and the FTSE 100 $ndexelf.

The first thing to realise with the London Stock Exchange, and indeed with all major share markets around the world, these are unusual in that trading is based on real cash transactions. Shares are traded for cash and bought and sold accordingly, and this market is therefore often referred to as the ‘cash market’. However, all major indices also have an equivalent futures index also quoted and for London this is provided by the NYSE Euronext LIFFE ( London International Financial Futures Exchange – now part of the New York Stock Exchange ) where futures prices are quoted for the FTSE 100, varying both in price and spread from that which is quoted by the London Stock Exchange for the underlying cash market. So to summarise, we have two ftse 100 indices, firstly we have that which is quoted by the LSE, and based on the performance of the weighted share components, whilst secondly we have the LIFFE quote a ftse 100 future, which is derived from the cash market prices and hence called a derivative. It is this underlying derivative index for the FTSE 100 that you will be betting on whether you spread bet, binary bet or use a fixed odds approach to your betting. As a result many traders are confused as the two prices quoted are rarely the same, and can often differ by some way, and to confuse matters further, some of the spread betting companies include the word ‘cash’ in their products, adding further confusion for new traders. So how and why do we have this added level of complication to what is an apparently simple bet! – let me try to explain.

As outlined above, the ftse index is the benchmark for a ‘cash’ market, and therefore as such any company offering a bet on the ftse 100, has to be able to hedge their bets in the market. In order to hedge their positions in the cash market they would need to buy or sell every single company within the index, clearly an impossible task. Therefore in order to allow them to hedge their positions they use the futures market. There is also another reason, and this is simply that the futures market updates more frequently than the cash market index. As you may recall, the ftse 100 cash index updates every 15 seconds, but for online spread betting, binary betting or indeed futures trading, this is far too slow, and as a result the futures index is used as it is updated second by second as the bids and offers come in from traders. The cash index does not update so quickly as it merely an indicator of the value of the top 100 companies and is therefore not a directly traded instrument, unlike a futures contract. Finally, there is in fact a third reason, which is simply that the $utures markets open for much longer trading hours, with most companies offering bets on the ftse from 07.00 am until 21.00 pm, extending considerably the trading hours of the cash market which only trades from 08.00 am until 16.30 pm each day.

Now moving on from here, the next stage is a little more complicated I’m afraid, but at least we have established the fact that ftse betting is based on the futures market and not the cash market, although of course the former is derived from the latter as with all derivative markets. The question which everyone asks now of course is how do the financial spread betting companies ( and others ) calculate their daily quotes for the ftse 100 index? The index quote is based on the $TSE futurestract from LIFFE, and is then priced using two variable elements. The first element is based on a theoretical value of any future dividends which may be payable between the current contract date, and the expiry of the futures contract, with the second element being the cost of the carry for the ftse 100 contract over the same period. This adjustment is referred to as the ‘fair value’ and is then built into the price quoted by the company, whether on a daily basis or over a longer term. In essence this ‘fair value’ element actually describes the concept very well, as it is essentially compensation to sellers for the cost of ‘storing’ or holding the assets and accepting a deferred payment as a result, and is in effect the cash or spot price, plus the net cost of the carry to the delivery date. In order to try to explain this principle in more detail let’s look at a simple example which I hope will make this concept clear, and naturally as the contract moves towards expiry then this ‘cost of carry’ reduces to zero as a result.

If we take a futures contract with a current cash price of 200p, and a loan rate of 5% with a dividend yield of 2.0%, then the fair value will be priced as follows for the next four months :

  • 30 days – 200 x 1 + 200 x ((0.03/365) x 30) = 200 + 0.5 = 200.50
  • 60 days – 200 x 1 + 200 x ((0.03/365) x 60) = 200 + 1.0 = 201.00
  • 90 days – 200 x 1 + 200 x ((0.03/365) x 90) = 200 + 1.5 = 201.50

As you can see from the above the fair value element is built into the price and reflects the ‘compensation’ element outlined above.This applies whether the bet is for one day, one month, or one quarter. Finally it is also important to realise that the futures markets lead the cash markets, not the other way round, a common misconception for many traders, so for ftse trading you need to watch the futures market not the cash market.

Finally a word about the contract periods that are offered for ftse betting. In general most of the spread betting companies offer the quarterly contracts which for the ftse are March, June, September and December, with many offering both daily and rolling daily bets. The difference between the two is that one expires on the day, whilst the other can be rolled over to the following day at a premium. Some of the terminology here can be confusing as many companies may also include the term ‘cash’, but the underlying principles remain the same – the price quoted is ALWAYS derived from the futures market for the ftse 100 contracts.