Spread betting is very popular in parts of Europe and Australasia, but often virtually unheard of in the United States. There are many Spread betting brokers out there that let you place bets on the FX Markets. It basically works similar to a bookmaker, except involving financial markets rather than sports, horses etc. This is not to dissimilar to the way many retail FX brokers work.
The arbitrage opportunity arises because with spread betting you often get the opportunity to open a trade and have the pip values in the base currency (The first currency in a pair). All retail FX brokers have the pip values priced in the quote currency (the second currency in a pair). For example if you open a 100k GBP/USD position, the pip values will be $10 per pip. With spread betting you have the opportunity to have the pip values in GBP. Unlike retail FX with spread betting you don’t open a set position size, you just select how much you would like to bet per pip movement. For example if you wanted to bet £5 per pip movement and the market moved 200 pips in your favor, you would have a floating position of +£1000. Margin requirements vary between brokers, but some only require margin for the maximum potential loss.
I imagine you are thinking, you can price the pips in pounds, so what? Let me explain how the arbitrage opportunity would work.
Let’s say we open a long position for £5 per point with the spread betting broker and short 100k GBP/USD position with a retail FX broker, this would give us $10 per pip movement, regardless of direction. These two positions must be opened simultaneously.
Let’s say on opening the positions the GBP/USD rate is $2.
If after a year the dollar weakens to $2.20, a 2000 pips move, let’s look where our positions would be:
The long GBP/USD at £5 per point would be have a floating profit of 2000*5=£10,000
The short 100k GBP/USD would have a floating loss of -2000*$10=-$20,000
In pounds this would be $-20,000/2.2 = -£9090
So the net profit would be £10000-£9090=£910
Now let’s look what would happen if price moved to $1.80.
The long would be -£10000
The short would be +$20000
The pound rate rate of the short position would be $20,000/1.80=£11111
So the net profit here would be £11111
So as you can see, no matter which way the market moves, the strategy ends in profit.
