While it may not seem obvious, a spread bet is, in fact, a type of derivative trading. A spread betting company is essentially a business offering a user-friendly interface to speculation in derivatives.

For example, a trader may think that the FTSE 100 is about to go up. He could open a Liffe trading account and buy a contract. However that contract would involve him making a £50,000 bet on the direction of the FTSE 100, because that is the minimum size of a FTSE 100 Liffe contract.

A spread betting company, however, will allow you to put a much smaller bet on the FTSE 100 because it can roll up all the exposure to these gambles in a batch and then lay this off by buying the large Liffe contract on the Liffe market. In effect, it often acts as an aggregator of many small bets, turning them into one large market position. This gives the spread betting companies the ability to offer FTSE 100 spread bets or Dax spread bets at any size you could want, down to as little as a penny a point.

Spread betting concepts in high finance
At this point it is probably a good juncture to revisit some spread betting basics. A spread bet offers a speculator the chance to bet long or short on a wide range on financial instruments at a 'bid offer spread'.

A spread better might buy Vodafone at 102 and sell it at 100. For the FTSE 100 there will be a six-point spread, so you can buy a position at say 4,006 and sell it at 4,000. There is always a six-point spread between the price you can buy and the price you can sell. The spread better therefore makes a gross of six points for every completed trade. Likewise, on the above Vodafone spread, he will make two points on every trade, either long or short.

If you had decided to bet a pound a point on the FTSE 100, the spread betters' fee for this position would amount to £6. This might not seem much, but at £10 a point, the position costs £60 a trade, and at £100 a point, it costs £600 a trade.

The spread better has one trading cost: the cost of laying off his bet on the market. This might be a single point on a liquid market like the FTSE 100 or an equivalently tiny percentage on the Dow or S&P 500, so he has a reasonable margin after passing on the risk of five points.

Additionally, if you paid £6 to go long at £1 a point and someone else paid £6 to go short at £1 a point, the spread better has a natural hedge and cannot lose on these two bets in aggregate. He has pocketed £12 and can sit back and watch both parties cancel each other out in his books.

Unfortunately for the spread betting company, speculators in the market are seldom in two minds, so the betting is either all long or all short and bookmakers are often forced to lay off their exposure in the market, at their own expense.

Although most people associate spread betting with equities and indices, there are a plethora of markets covered by modern spread betting companies. Today, the universe of speculation has spread to currencies, bonds, interest rates, traded options, commodities and even house prices.

For a trader this is an exciting menu of opportunity. To get direct market access to all these instruments would be fabulously time consuming and expensive, whereas a spread better, for a modest tariff, opens up all these avenues with a single online account.

Dabbling in Libor futures is not for the faint hearted, but nonetheless, market access in its own right is an asset even if you never take a position. For example with an open account, you will never miss that opportunity to make a killing in a particular currency, because it removes the need to spend a couple of weeks opening a currency trading account.

For equities, the benefits are more obvious. There is no stamp duty on a spread bet. For an intra-day or active trader, a 0.5% tax is a near impossible hurdle to vault. A trader must look to shield himself from this expensive barrier and can do so with a spread bet.

This is a tax advantage that contracts for difference (CFDs) also enjoy, but spread betting has a spectacular added benefit. There is no taxation on profits from spread betting, unless the revenue can prove you are a pro. Cynics are quick to point out that you must first make a profit, but still, this tax break is an extremely attractive feature.

Make your cash work harder for you
Another attractive feature of spread betting is leverage. To the non-gambler, leverage is not a benefit but a demonic temptation. On average, a spread betting firm will give an index speculator 20 times leverage. That is to say, if you want a £1 a point exposure to the FTSE, which is worth £4,500 of exposure, you can have it for just £225.

Of course if the market runs against you, soon you will be called upon to top up your account. However, the upside potential of leverage if you are right can be immense. This is a very compelling feature for those with either absolute faith in their judgment or, as some might suggest, a lack of understanding of the fundamentals of risk. If a punter puts £225 into his account and then takes a £1 a point bet on the FTSE and the market goes up 225 points in a month, he will double his money. It does not require recourse to a sophisticated spreadsheet program to work out the impact of doubling your money each month. At that rate, a little money becomes a lot of money in a relatively short period.

Sadly, it is remarkably hard to be consistently right, and high leverage can act very much against a speculator's chances. The laws of over-betting mean they will most probably get forced out of their position by a contra-move caused by general volatility. This leaves the speculator out of the game for good even though his position might be proved to be generally correct in the long run. The impact of leverage on a step in the wrong direction proves as powerful in destroying capital as creating it.

The thing to remember about leverage though is that it is not compulsory to use it. As with any tool, understanding its impact and its range of applications can turn it from a blunt instrument into a useful device.

Hedge your wedge
Spread betting has more applications than it is often credited with. It's generally thought of as a trading or short-term investment tool, but underlying the creation and use of derivatives is the concept of hedging.

For example, anyone with a sizable portfolio might reach a point where they are worried that the market might crash. Traditionally, they have few options but to sit tight or sell out. The trouble with selling is that the costs can be significant. Brokerage charges, spreads and perhaps even the crystallisation of tax liabilities can be very costly.

Let's say the portfolio in question was worth £1 million. Getting in and out might cost 2% brokerage, 0.5% stamp duty and 1% spread. That is a total of £35,000. Getting out of the market to re-enter later is therefore an expensive manoeuvre.

Yet by selling £50,000 worth of stock and lodging it with a spread better, the whole portfolio could be hedged against the FTSE 100 for three months for around £1,400. For a few hundred more, another three months could be tacked on.

It would of course be an expensive pain if the market continued to go higher, but once again, powerful tools should not be wielded lightly.

One of the down sides of spread betting is that it is easy to misunderstand the risks and costs. For example, the spread - and therefore cost - of a FTSE 100 or Dow spread bet can seem small. Because of this, many will try to trade the intraday moves of an index in order to capture very short-term moves. However, if you crunch the numbers, it becomes clear that the spread represents around 10% of the daily range of the index price. This is a high barrier to jump to make a profit and the possibility to profit in the long run starts to shrink horribly if you were to trade several times a day.

Likewise, contracts are of a finite period, and renewing contracts quarterly can add up to a big cost. Personally, on equity spread bets, I take longer-term contracts where possible. On a per day basis, these work out cheaper than short period bets. Timing is notoriously difficult to judge, and moves, even when you are right, very often take longer to occur than expected. Like most serious trading or investment, cost controls can be as important as risk management in delivering final returns.

Few spread betters understand the amount capital they have at risk when using leverage. I have spoken time and time again to active index 'traders' who are aghast when I explain that their £50 a point on the Dow is a £500,000 capital at risk position. Of course the market volatility means that they cannot lose ALL of that £500,000, but markets have dropped 25% in a day or two, and will do so again. With an understanding of capital at risk, disaster can be avoided, but the user friendliness of spread betting can lull people into a false sense of security.

However, having said all that, I maintain that any serious investor or trader should have a spread betting account. The sheer breadth of markets that can be accessed via today's online spread betters is a feast for anyone with a head and heart for speculation. While certainly not for the inept or totally inexperienced, spread betting is an extremely flexible, cost effective and user-friendly way to gain access to the biggest games in town.

Clem Chambers is the CEO of online financial information provider ADVFN (www.advfn.com). Email him at clemcham@advfn.com