What CFDs are, and how they work
A CFD is a financial derivative that represents a theoretical order to buy or sell a tradeable asset — say, a certain number of shares, or amount of gold. The investor simply closes the transaction by taking the opposite action. The investor’s profit or loss is the difference between the opening and closing price. It is paid at the close of the contract.
A simple example of how the concept works is a CFD over shares. The price of a CFD is derived from the spread — the highest buying price ( bid) and lowest selling price ( offer) that is quoted on the Australian Securities Exchange ( ASX) — so the value of the CFD mirrors the share price. ■ An investor buying a ‘‘ long’’ CFD benefits from a rise in the share price, while a ‘‘ short’’ CFD gives the benefit of a fall in the share price. The CFD moves identically with the underlying shares: if the share price rises one cent, the investor is paid one cent. CFDs allow traders to leverage an investment with a deposit of as little as 3 per cent. ■ With a stop- loss — a protection mechanism that automatically triggers a sell order at a pre- determined price — investors can limit their downside using CFDs.
CFDs compete mainly with exchangetraded options ( ETOs) and margin lending. CFDs give the same leveraged speculation opportunities as options, but it is much simpler — there is no ‘‘ time decay’’ and investors do not need to trouble themselves with option- related concepts such as delta, gamma and vega. ■ Compared to margin lending, CFDs work in a similar but simpler way, and with more gearing: the investor pays interest on a long ( buying) position, and receives interest on a short ( selling) position. ■ On the debit side, investors can’t use a buy- write strategy ( writing, or selling, options over a shareholding to bring in extra income) as easily using CFDs. ■ Investors who believe a stock in their portfolio is going to fall — but who don’t want to sell it — can ‘‘ short’’ it using CFDs. When the share price drops, even though the value of their holding falls, they make a profit on the CFDs and the two can offset each other. ■ is that The holder of a short CFD is paid interest while the position is open — whereas the holder of a short position in ETOs effectively pays time decay for that position. Also, because a CFD position is independent of the shares, the investor can’t lose the shares.