How Does CFD Trading Work? CFDs Explained

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  • How Are CFDs Taxed? Guide To Taxes On CFDs

    How Are CFDs Taxed? Guide To Taxes On CFDs

    One of the advantages of CFDs over regular share trading is the comparatively favourable tax treatment of the former, providing traders with a more cost-effective way to invest. While the tax treatment of contracts for difference is naturally variable from jurisdiction to jurisdiction, the UK makes special provisions for CFDs as a result of certain of their characteristics, ensuring the trading model falls outwith the parameters of certain otherwise chargeable taxes.

    Just like trading in shares, disposal of contracts for difference will attract capital gains tax liability to the extent to which any profits exceed the annual exemption. Bear in mind that capital gains tax is a complicated tax, with a variety of reliefs that may come in to play beyond the annual exemption amount, and so for more significant disposals it may be well worth seeking professional advice on the tax treatment, and any means by which capital gains tax liability can be minimised.

    Avoid Stamp Duty with Contracts For Difference

    Where contracts for difference differ from the trading of shares is in stamp duty liability. Stamp duty is charged on share transactions at a rate of 0.5%, and unless you’ve got a keen eye you won’t even be aware it’s being deducted when trading through an online broker until you notice the corresponding dent in your trading account. When trading in CFDs, stamp duty is not applicable, given that is only related to the buying and selling of land and shares – CFDs being derivative, intangible instruments do not attract liability to this form of tax.

    While this does present a saving of 0.5%, it doesn’t necessarily mean CFDs are always destined to be the most profitable way to invest. For example, if you were looking to establish a long position in Company X over a number of years, you might be tempted to think that CFDs are the way to go to avoid paying stamp duty – in actuality, paying the 0.5% duty and investing pound-for-pound will circumvent the need for high interest and financing costs, which will in this case more often than not prove prohibitive for the investor.

    CFD Trading Tax Flexibilities

    Another key benefit of trading CFDs which makes them a vital tool to have in your locker is their flexibility, which presents a variety of options for legitimately managing your exposure to taxation. One of the most commonly witnessed examples of this pertains to so-called ‘bed and breakfasting’ – the illegal process of offloading assets at the end of one tax year only to instantly buy them back the next with a view to capitalising on allowances and exemptions on both sides of the financial year.

    Provisions put in place to stop bed and breakfasting require that any shares reacquired in the 30 days following their disposal be treated as having never been disposed for tax purposes – however, clever management of CFDs can create the same tax saving effect without contravening the law.

    When the positions are offloaded, simply opening positions to tie in the current market price with contracts for difference will guarantee you the ability to regain your shares at a future point outside of the 30-day period, thus allowing you to circumvent the tax liability you would otherwise face.

    While these represent but a few brief examples of the taxation angle to CFDs, it is hoped that the flexibility and malleability of CFDs as a trading tool can be applied in creative ways to minimise tax exposure and reduce the likelihood of significant tax liability on any particular trade.

    Whenever you are engaging in transactional activity, it’s important to have a think about the tax consequences of your actions. While a trade might look juicy in prospect, understanding the impact of tax is critical to accurate forecasting and remaining in compliance with the law. Fortunately, the savvy trader is able to take advantage of provisions in the tax statutes that allow for certain reliefs and discounts to be factored in to the annual trading tax bill. But firstly, it’s important to understand exactly how CFDs are taxed and what liability you may be opening yourself up to face.

    Whenever you are engaging in transactional activity, it’s important to have a think about the tax consequences of your actions. While a trade might look juicy in prospect, understanding the impact of tax is critical to accurate forecasting and remaining in compliance with the law. Fortunately, the savvy trader is able to take advantage of provisions in the tax statutes that allow for certain reliefs and discounts to be factored in to the annual trading tax bill. But firstly, it’s important to understand exactly how CFDs are taxed and what liability you may be opening yourself up to face.

    Example of UK Tax CFD Treatment

    UK CFD tax treatmentIn the UK, CFDs are exempt from stamp duty but do attract capital gains tax (CGT). This is a tax payable on increases in capital, similar to income tax for lump sum asset disposals. Because CFDs are assets that look specifically at the difference in capital, they are regarded as taxable for CGT purposes. This gives rise to tax at 18%, or 28% for higher rate tax payers, and can therefore account for a substantial proportion of your profits. There is clearly a real incentive for traders to look to reliefs and discounts afforded by law, and there are several easy tips you can integrate into your trading that will save you money without the need for an accountant.

    Use It Or Lose It

    Each tax year, individuals have an annual exemption for capital gains above which CGT is charged. For the year 2011-2012, the annual exemption stands at £10,600 per person, meaning that the first £10,600 will be tax-free. Remember that this covers all asset disposals in the year and is not restricted to CFD transactions.

    This amount is extended to every UK citizen on an annual basis, and cannot be rolled over from one year to the next. This leads to some distortions in the CFD markets as traders look to sell up early to take full advantage of their annual exemption, only to later buy back the positions with access to a new year’s annual exemption on the same transaction. This process was known as bed and breakfasting, and has since been restricted by regulations requiring a period of around a month after the disposal before the same instruments can be bought. However, there are similar techniques that can be used by traders to ensure the benefit from their entitled annual exemption before it expires.

    Carrying Losses

    Another effective way in which taxes can be reduced is through carrying over any losses into the following tax year. If you realise a loss from your CFD trading activities for the year, this amount can be carried forward as a deduction from your next profitable year. This has the effect of making it feel like a tax discount when you do realise a profit. Remember also that there may be legitimate reasons for making a loss from your trading, and it may be the case that it works out financially beneficial to do so.

    While there are several strategies traders can deploy today, the laws surrounding CGT and how CFDs are taxed are subject to constant scrutiny and change. For that reason, its critical to pay close attention to the treatment of CFDs for tax, in order to ensure you remain fore mostly above the law, and second in the strongest possible position to minimise your liability.

  • Dividends and Corporate Actions with CFDs

    Dividends and Corporate Actions with CFDs

    Holding positions in CFDs relative to the shares in an underlying company are preferred by many traders as a cleaner, more tax-friendly way of backing a company that shows signs of promise. Because CFDs trade on the basis of shares, but transfer no rights and responsibilities to the holder, they are less involved than shares, and fundamentally more straightforward instruments. One of the drawbacks of non-entitlement to shareholder rights is the situation regarding dividends, and without some specific treatment by CFD brokers this can lead to an obvious imbalance in the pricing of the contracts they offer.

    A dividend is a payment made to shareholders from a declared dividend fund, paid out on a per-share basis from a portion of the net profits after tax and retained sums.

    As a shareholder, dividends are declared and paid to you by the company, offering a residual yield and building in some value in actually owning shares. But for holders of contracts for difference, which may very well pertain to the shares of the very same company declaring a dividend, how is this apparent anomaly rectified?

    Dividend Payments and Contracts For Difference

    It would seem particularly harsh on traders if dividend payments made no impact on the value of their contracts, and at any rate that wouldn’t be a true reflection of the value of their positions. The inherent value of an asset increases when it has a proven and demonstrable yield, and any company that finds itself in a position to declare a dividend is usually doing so off the back of a highly profitable, strong trading year. Therefore the very presence of a declared dividend is sufficient to increase the value of the shares in the relevant company, and all instruments and trading assets derived from those shares.

    For traders holding long CFD positions at the time of a dividend declaration, the situation is rectified by the broker factoring in the additional value of the dividend into the value of the CFDs, often at a rate less than 100% of the declared dividend value. This effectively ensures CFD holders benefit from the declaration of the dividend as they should, without any recourse to claim the dividend from the company.

    It is important also to note that dividend declarations are also paid on short positions, and (unsurprisingly) brokers tend to do so at no less than 100% of the dividend amount. When taken into consideration, a paid dividend on a short position is actually a subtraction in value, given that you’re anticipating a fall in value, and so it pays to be on top of when dividends are likely to be announced to ensure you don’t get caught up as a result of a hefty payout.

    Other Corporate Action Effects

    Likewise, with other corporate actions (such as, for example, a rights issue), the trader is open to receiving the benefits and drawbacks of the decision where otherwise without ownership they might expect to be cut out of the loop. In order to consistently reflect the true value of the underlying assets to which they relate, CFD brokers take steps to ensure every corporate action that bears on shareholders also bears on CFD traders, so it’s important to make sure you’re on the ball when it comes to leaving open positions ahead of corporate announcements.

  • CFD and DMA – How To Use DMA With CFDs?

    CFD and DMA – How To Use DMA With CFDs?

    The way we approach financial trading today is more direct and far more accessible than it has ever been before. Sophisticated online platforms offer us insights into multiple financial markets instantaneously that we could never have achieved even 20 years ago, and the growth in retail investing through online brokers, thanks to new innovative instruments like CFDs, has been staggering. Arguably one of the biggest innovations to come from the development of technology in trading is the widespread growth of DMA, allowing traders of all levels and sizes to make their own trading decisions on the markets first hand.

    What Is Direct Market Access?

    In most CFD trading scenarios, the trader takes a position against the broker, in a direct two party contract in isolation of the markets. While the value of the position depends on what happens in the underlying public market, the contract is made directly between the broker and the trader. In some instances, traders may prefer to deal in exchange-traded CFDs, and an increasing number of brokers are providing DMA functionality to allow traders a more straightforward route to the global exchanges.

    DMA stands for ‘direct market access’, and is the functionality that allows traders to execute trades directly in the underlying markets. For CFD traders, these positions are executed directly in the relevant exchange-traded CFD market, with the broker merely the facilitator of the transaction. As technologies have improved and become more accessible and widely distributed throughout the retail investor market, the growth in DMA brokers and DMA service providers has been considerable, helping to bring a new generation of traders to a more direct trading process.

    The Benefits of DMA and How to Use It with CFD Trading

    DMA trading has many benefits for the experienced trader. Firstly, it can deliver greater price transparency than broker quoted CFDs, simply because the position is opened in the market directly. This means you are buying and selling CFDs are their optimum market prices, rather than accepting clipped prices from the broker. Alongside greater transparency is an ability to offer at more flexible prices. Depending on what the market wants to pay for your positions, you can sell for a more customised price through DMA trading than through broker traded CFDs.

    Of course, this does have to be tempered with the issue of liquidity – unlike broker filled CFDs, DMA traded CFDs will require an active counterparty to be found, which can have liquidity problems and affect the final closing price, depending on the particular markets you are trading. That said, DMA can nevertheless give more control and flexibility to the trader, and can pave the way for alternative trading strategies to be deployed.

    Direct market access allows traders to execute positions on global exchanges directly, and can provide a variety of benefits to CFD traders, depending on the markets they are looking to trade. Now a feature of an ever-increasing number of online brokers, the growth in DMA is a living testimony to the impact of advancing Internet technologies on the financial trading world.

  • CFD Demo Account – How to Start Trading CFDs?

    CFD Demo Account – How to Start Trading CFDs?

    As with most forms of trading and investing, CFD brokers tend to offer demo accounts trading virtual money as part of their marketing strategy. While not everyone will relish the prospect of investing their time and effort in trading for no reward, demo accounts come thoroughly recommended as a pre-trading tool, and provide the ideal environment for new traders to get to grips with their chosen platforms and learn the basics of their trading strategy before getting involved for real. But what are the benefits of trading CFDs through a demo account, and how does this play in to improving trading success?

    Demo accounts are a great way of researching different trading platforms and trying out various brokers for size. The demo account is essentially an exact replica of a regular trading account, trading on live markets and applying commissions and leverage costs as would be the case if real money was at stake – the only difference is that positions are virtual, and so profits and losses are for illustrative purposes only.

    Learning the Platform with a Demo Account

    This makes it possible to get a feel for the trading interface, and provides the perfect setting for new traders to learn how to execute orders, set stops and interpret live market data to make trading decisions. In the absence of a virtual account, early mistakes in both trading style and execution can be costly, whereas the virtual environment provides a risk-free platform in which traders can refine their style and build on their theoretical knowledge.

    In addition to serving as an important research tool for helping differentiate between brokers, demo accounts are also an essential part of the learning experience, affording no-risk trading on real markets to provide an opportunity to try out different trading strategies and put the theory into practice. Particularly considering the extent to which losses can be magnified in trading CFDs, demo accounts are especially important in bridging the gap between knowledge and experience.

    Multiple CFD Demo Accounts

    Many new traders make the mistake of settling for just one demo account, and try to fit in their trading style around the setup and layout of the broker’s platform. In actuality, a better strategy is to open several different virtual trading accounts to give a broader cross-section of what the market has to offer. Only by experiencing different brokers first hand can you start to form an idea of which offers the best package for you, and without a thorough examination of demo trading accounts you’re effectively taking a punt in assuming your chosen broker has the most to offer.

    While demo accounts are a useful tool for traders looking to try their hand at CFD trading without incorporating risk, it is important to care for your account as if it were real capital. All too often traders fall into the trap of taking unrealistic risks, or making whimsical decisions that they would be more reluctant to make if they were investing their own capital. It’s obviously difficult to have exactly the same attitude when trading virtual cash, but it’s important that you take steps to ensure you’re trading as you would in the real world at all times, in order to give a more predictable indication of how your theory is working in practice. Ultimately, while your overall performance in your demo account gives a rough guide as to how you might get on trading for real, it is a dangerous tactic to rely on past performance trading virtual cash as an indicator of sure-fire success when you start hitting the markets for real.

    Learning With a Demo Account

    It might seem that you waste time with a demo account; it is not entirely true.

    Of course, you’ll learn much more with a real account but demo account are still important as you trade demo money and thus you eliminate the risks and emotions. Just try for yourself to trade micro lots and demo account and you’ll see the difference as even with micro lots you’d be trading your own money and you’d care more.

  • CFDs vs Share Dealing – Difference Between CFDs and Trading Stocks

    CFDs vs Share Dealing – Difference Between CFDs and Trading Stocks

    Perhaps the best benchmark for comparison of the features of CFDs is share dealing in the traditional sense. When we think of investing, our default position is to imagine the trader buying and selling shares on a straightforward, pound-for-pound basis, cashing in on the difference between the price on the day shares are bought and that on the day they are sold.

    In reality, the markets are much more complex, with a wide range of tradable assets on offer, of which CFDs are but one. So how do the two compare, and what are the specific characteristics of CFDs that lend them as an instrument class to profitable trading?

    Trading and Leverage

    The obvious key advantage with CFDs over straight share dealing is the leverage effect. Trading on margin, CFDs allow traders to take an often-vast exposure to a position without the need to stump up all the required cash. This serves to boost the earnings potential of any given trade, while also equalling increasing the risk profile of taking a particular position.

    With share dealing, trading is conducted on an unleveraged, non-margined basis, limiting the profit potential of a single trade (and indeed the exposure to risk). Thus, share dealing represents the more conservative trading form of the two, with CFDs allowing traders to stack up behind sure-fire positions to increase earnings.

    The Ownership of Underlying Assets

    Another difference between the two lies in the rights being traded. With share dealing, investors are buying assets with an inherent value and yield in their own right. Shareholders are entitled to vote on strategic decisions affecting the future of the company, and are entitled to a regular dividend payment from corporate profits. As a CFD holder, your have no such entitlement, because you don’t in fact own any of these rights. However, CFD brokers will still reflect dividend payments and other corporate actions by factoring these in to the value of the CFD positions you hold, ensuring that your positions benefit from corporate goings on in spite of your lack of corporate ownership.

    Tax Treatment for CFDs and Stock Trading

    When deciding whether to trade CFDs or shares, the differing tax treatment of the two instruments must also be factored in to any calculations of cost efficiency. CFDs are exempt from stamp duty, charged automatically on share transactions at a rate of 0.5% of transaction value. However, CFD positions can be more expensive in the long run as interest and higher transaction costs take hold, and it depends on the nature and length of the position you wish to take which will work out most cost effective.

    Thankfully, contracts for difference and trading in simple shares are not mutually exclusive, and savvy traders tend to employ a degree of both across their portfolio to diversify risk and make the most of the different trading options available to them. That said, it’s advisable to have a strong grasp of the pros and cons of each form of trading at your disposal before settling on one or the other for a particular transaction, and by employing CFDs and share dealing in tandem as part of a wider strategy, it can be possible to secure the advantages contributed by both instruments to maximise your trading income.

  • CFDs vs Spread Betting – Difference Between CFDs and Spread Betting

    CFDs vs Spread Betting – Difference Between CFDs and Spread Betting

    Contracts for difference and spread betting are amongst two of the most popular trading methods in the UK, accounting for a considerable proportion of individual and private trade. Not permitted stateside as a result of securities regulations, the two are examples of the ingenuity of financiers to create trading platforms which offer investors the means to speculate on the movements of virtually any market or index, and provide opportunities for the trader to leverage his expertise without actually exchanging any underlying assets.

    Indeed, the two have a number of similarities. Both are highly leveraged types of trading, which can deliver multiple times the initial position in profit with absolutely no upwards limit on earnings. Both deliver economically similar results, steering largely clear of the market and provide traders with practically the same financial effect, and both are notorious for being particularly risky, with the ever present threat of unlimited down side liability.

    Tax Difference between CFDs and Spread Betting

    But it’s where CFDs and spread betting differ that really matters. Firstly, and perhaps most importantly, financial spread betting carries a considerable tax advantage in situations where it does not provide the trader’s mainstream of income. Because spread betting is regulated in the UK as a gambling activity rather than an investment activity, and no assets (which include tradable instruments) are actually changing hands, capital gains tax is not payable on the profits from spread betting – with contracts for difference, that’s not the case.

    CFDs do attract CGT liability, although like financial spread betting they remain exempt from stamp duty, thus providing a means of accessing securities without the need to incorporate the relevant 0.5% liability – a saving that is of particular use to larger investors. Similarly, losses from trading contracts for difference can be carried forward and applied in relief against future trading profits to reduce overall liability on your trading income, whereas spread betting doesn’t benefit from any such relief, for the same reasons as it enjoys exemption from CGT.

    More on Financial Spread Betting vs CFD Trading

    Aside from the tax issue, there are also points of difference to be highlighted in the way in which pricing is pitched to the investor. In spread betting concern is cast to the number of PIPS in movement of a position, with PIPS X STAKE providing the profit component. With CFD trading, positions are quoted in a manner more akin to share dealing, with traders in a position to take either a long or short position on the market in a way that is almost indistinguishable from other types of share dealing.

    Furthermore, CFD brokers on the whole tend to derive their profit from transaction fees, charging a percentage of the margined total position in addition to interest fees for the leverage provided. In contrast, spread betting brokers normally make their profits from the spreads they build in, reflecting a certain number of pips in every trade which ensures a portion for the broker whether the markets move up or down. For many traders, the latter proves the more attractive option of the two, preferring to pay out of earned profits rather than footing the bill in the form of commissions up front.

    While spread betting and contracts for difference are similar in a number of key ways, they nevertheless have their differences in characteristics and style, and the advantages of both make them more or less amenable to particular trading situations. Regardless of the most appropriate option for the given trading scenario, both spread betting and contracts for difference equip traders with the ability to ramp up their earnings potential from single trades, while providing some degree of tax advantage over regular share trading.

  • CFDs vs Forex – Difference Between CFDs and Forex

    CFDs vs Forex – Difference Between CFDs and Forex

    Contracts for difference and forex trading are both amongst some of the highest leveraged forms of trading around, and as such both hold the allure of taking the individual investor to the big time. Notoriously, forex is a very difficult and unpredictable form of trading, and the interplay of leveraged risks is never a helping-hand when it comes to calming the nerves. That said, both are considered high-yield trading strategies, although completely distinct in their own right.

    Key Features of CFDs and Forex

    The forex market is traded more than any other, and estimates suggest that over 120 currencies are traded to the combined value of trillions of dollars every single day. The vast majority of these trades are on a leveraged basis, just like CFDs, and forex brokers often tend to gear up to ratios way beyond those that would be achievable in the CFD market.

    To add a further layer of complexity, forex can actually be traded with contracts for difference, using the pricings of different currency pairings as the index on which the contracts are dependent. For the purposes of trading CFDs, it’s irrelevant whether the underlying index is a currency pairing or a stock index – no currency is changing hands, and no obligations other than those to the broker are being incurred.

    One of the major drawbacks with any type of leveraged trading is the financing costs applicable, and in this regard both CFDs and forex are hampered over the longer term given that costs escalate by the day in terms of interest and fees. This makes it essential to conduct a full cost analysis of every trade before you commit, ensuring that over the term of your trade you can comfortably cover the costs of trading and financing in addition to delivering a profit. And with overnight financing costs and large transaction fees to boot, this isn’t always as easy a task as it seems.

    Key Difference Between CFDs and Forex

    One of the core differences, and indeed the main advantage of trading forex through CFDs rather than through a traditional forex platform is a single, unified currency. Rather than having to convert between currencies and hold balances in different currency types, CFDs make it possible to deal only in your chosen ‘home’ currency, which creates both a cost and hassle saving for the trader.

    For example, say you live in the UK and want to speculate on currency fluctuations between the EURUSD currency pairing. If you close your position in Euros for a profit of EUR500, that is reflected on your account as a Euro balance, and still needs to be converted into a usable currency (i.e. GBP). This means potentially another layer of commission, and there’s no way of ensuring that the exchange rate will work in your favour – indeed the exchange rate might well be on a downwards trajectory when you close your position.

    With CFDs, the contracts are all handled in the one currency, with the price point at which you enter the trade on the currency pairing acting as a baseline for your index. This cuts out the extra layer or hassle and cost to give a more streamlined investment product that still benefits from margin but without the additional commissions, fees and hassle surrounding converting your capital and managing multi-currency trading balances.

    Trading the forex markets can be particularly fast-paced and exciting, and for the economically minded it can be a great way to exploit macroeconomic movements and current affairs. In recent times there has been a shift in favour of CFD brokers, many of whom now brand themselves as ‘CFD Forex’ brokers to cash in on the many advantages CFDs have to offer, and the flexibility afforded to traders makes this a more than viable alternative to regular forex trading.

  • CFDs vs Futures – Difference Between CFDs and Futures

    CFDs vs Futures – Difference Between CFDs and Futures

    Contracts for difference and futures on the face of things seem like rather similar instruments, which both providing the trader with a price tie in to be crystallised at some future point to realise a profit. Both are derivative instruments – that is to say, secondary instruments traded on the strength of underlying markets or indices – and both can be highly leveraged to maximise the earnings potential of a given trade. But in spite of their apparent similarities, CFDs are actually vastly different to futures contracts, and their contrasting characteristics should be factored in when considering which instrument is best for a particular trade.

    Where Are Futures and CFDs Traded?

    Firstly, CFDs tend to be largely traded off-exchange, with the broker being the second party to any transaction and any profits and losses arising paid by and to the broker orchestrating the deal. This means that the range and scope of CFDs on offer is determined by the individual broker, and there is little rigid uniformity across different brokers as to pricing and the markets they offer. Futures on the other hand tend to be traded on futures exchanges, meaning they are readily tradable amongst other investors and directly reflect underlying market movements in the assets to which they relate.

    Expiry Date for CFDs and Futures

    The second core difference between the two instruments is that contracts for difference are open-ended and can be held for any length of time (insofar as the costs of maintaining a highly leveraged position permit. Futures are sold with a specified maturity date on which they are exercised, giving less flexibility to the trader and giving rise to the phenomenon of price decay as their value shrinks in the run up to the point of expiry.

    Cost Difference

    Another obvious difference between the two instruments is the lower price entry point of trading contracts for difference, afforded as a result of their highly margined nature, versus futures which require a higher level of trader investment up front. While this isn’t necessarily an advantage for CFDs given the need to maintain and fund margin requirements for leverage, it does make CFDs a more attractive proposition for less experienced traders looking to get a low-cost foothold in this type of market.

    What both instruments have in their favour is the ability to call and profit from future outcomes without actually having to invest in the underlying asset, and this form of derivative trading allows natural leverage to increase the potential gains from positive price movements.

    Consider the example of a 5% rise in Company X’s share price. This rise will in turn lead to a proportionately higher rise in the value of futures contracts, for examples sake, where momentum suggests underlying shares may continue to rise over time. This effectively ensures the trader can profit at a greater level than would be the case with straight-forward investing in the underlying stocks, and particularly in the case of contracts for difference the heightened leverage potential only serves to exaggerate the potential gains even further.

    Conclusion

    Getting to grips with the nuances and the pros and cons of different trading instruments is essential to building a solid portfolio, and while futures and CFDs do bear a number of notable similarities it’s important to remember they are fundamentally different products, with fundamentally different characteristics which may lend themselves more closely to specific trading scenarios.

  • CFDs vs Options – Difference Between CFDs and Options

    CFDs vs Options – Difference Between CFDs and Options

    CFDs and options bear a number of similarities, but also a number of key differences, and both are suited to their own particular purposes. Unlike share dealing, where traders are engaging in the underlying asset, options are also derivative instruments which in themselves are naturally leveraged. That said, there are several notable differences around leverage and the actual pricing of the instruments that distances any similarities, and while at first glance the two may appear to be similar there are a number of important bases for comparison.

    While contracts for difference are agreements to close out a contract for the profit (or loss) in the difference between the opening price and closing price of an instrument, options are simply rights to later purchase shares or commodities at a set price.

    Options are bought at a fraction of the underlying asset price, and give the trader the right to later acquire the asset if he so chooses – usually, where it proves profitable to do so. The profit portion for the trader comes in later exercising his options when the market for the asset concerned rises – thus Profit = Selling Price – (Buying Price + Option Price).

    Options Features

    In terms of practical differences, firstly the transparency of instrument pricing differs greatly between CFDs and options, with CFDs being a more accurate tracker of underlying markets than options for a number of reasons. Options suffer, in the same way as futures, from a decline in their price point as their expiry looms, and indeed it is only logical that this would be the case – the value of the right to buy the shares is, after all, less valuable with less time to exercise that right in your favour before it becomes void, thus it is often harder to get a gauge of whether an option represents true value and a fair reflection of the underlying asset market.

    Contracts For Difference Features

    CFDs on the other hand, particularly those marketed by direct access brokers, track the underlying market virtually tick for tick, because brokers are obliged to match corresponding CFD positions with live positions in the underlying asset market, as a hedge against risk and a value-added service to traders. This can make it far easier to follow how the pricing is laid out, and with the exception of certain ‘market makers’, who as brokers have responsibility to set their own spreads and price points, this presents a much more transparent and clear representation of price.

    Another immediate advantage of contracts for difference is that they are available to be traded on a considerably wider range of bases than options – including indices, exchange rates, bonds, etc. Options can only be traded on the basis that there is some underlying asset, and so cannot be traded in conjunction with any index or rate, tying the investor’s hands as far as options are concerned. Depending on which bases you are looking to trade this may or may not pose a problem, but for new traders looking for as much flexibility as possible, contracts for difference do seem better equipped to fulfill that role.

  • Contracts For Difference (CFDs) Guide

    Contracts For Difference (CFDs) Guide

    This section covers Contracts For Difference in more detail. CFD can be a great trading instrument but it has its pro’s and con’s and it’s vital to understand how CFDs work and how to use them to a trader’s advantage.

    1. CFDs vs Section: learn how CFDs are different to other trading instruments such as how they are different to Options or Futures.
    2. Essentials: the section covers the most important aspects of CFD trading and how to make the most out of your trading. If you are new to trading, don’t forget to check what types of orders are available and how to use them.
    3. Misc: stands for “miscellaneous”, covers the topics such as as the history and how CFDs became so popular around the world. It also covers more complex topics.

    Contracts For Difference Guide

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