Contracts for difference - CFDs - have only been available to private investors since the late 1990s, though institutional investors and hedge funds had already been using them for years. They're an interesting form of equities derivative, offering the opportunity for gearing, but unlike options and covered warrants, having no expiry date.
And CFDs now offer more than equity derivatives, as you can also get CFDs on indices and currencies - so you could, for instance, buy the FTSE, or sell the dollar, using CFDs. With a contract for difference, you're making a contract with the CFD provider that you will pay the different between the current value of the asset covered by the CFD, and its value at contract time. The trade is struck between you and the CFD provider - this is a direct contract, not traded on an exchange. If you want to close your position, you simply make a reverse trade.
CFDs are traded on margin, so you get more bang for your buck - you can make a greater profit but equally, of course, you can make a larger loss. Unlike equities, where you cannot lose more than you put in, of course while you're margin trading you can lose vastly more than your original stake. You'll find different brokers give different margin on different CFDs, but generally you'll be putting up between 3% and 15% of the cost of the equity stake as margin.
This isn't free. You'll be paying 0.1% to 0.25% commission - much cheaper than buying the underlying equity. And there's no stamp duty to pay, either, so that's another cost saving. You will, however, pay a financing charge every time you roll the position overnight. You'll also find that if your position starts losing money, the provider is likely to make a margin call - asking you to put more money up to cover the contract. Margin calls must be quickly met or the position can be liquidated.
By the way, if you've bought a CFD on a yield stock like Royal Dutch Shell B or Glaxosmithkline, you'll be happy to know that you are entitled to any dividends paid in the period you hold the CFD.
CFDs work in a way that's not very different from spread betting. However, they lack the tax advantages of spread betting. Because spread betting is seen as gambling, whether it's on…
