Category - Compare

Know what CFDs are

Contracts for differences have proven to be very popular across the world stock exchanges, leveraging off their main advantages over other established financial market products. CFDs allow traders and investors to profit off changes in the prices of stocks, indices, commodities and other underlying assets.

But which trading products provide the best opportunities for day traders? As well as decisions on how and why to trade, many stock market traders have to take decisions about what instruments to trade. In this respect it is useful to compare the features of CFDs with other geared investment products such as covered forex, futures, options or warrants before deciding which instrument is best for individual needs. For instance, warrants have a short-term, finite lifespan and require knowledge of how volatility works but are traded on an exchange, whereas contracts for differences theoretically have an unlimited lifespan and need not require volatility calculations but are mostly not traded on an exchange (apart from Australia). Some investors consider CFDs, futures and spread betting as roughly similar products and although it is true that they all basically work in a similar way, there are a number of differences that need to be considered. Futures and spread betting are virtually identical and in fact spread betting providers often base contracts around an underlying futures product although spread bets differ from futures in the sense that they are exempt from Capital Gains Tax.

CFDs are subject to CGT but are more transparent than spread betting and the difference between bid and offer prices is usually always tighter than spreadbets. CFDs also have no minimum deal size or minimum deposit requirement. In the range of financial market instruments used for speculation such as futures, options and covered warrants, contracts for differences are rated higher due to their relatively easier accessibility, lower costs, price simplicity and wider range of underlying instruments.

A CFD can be compared to -:

— An equity swap with no determined expiry date that is in effect financed by cash margin. A CFD is a derivative of an underlying asset and forgoes the advantages of owning the underlying instrument on a direct basis for a product that is traded on margin and thus allows more leverage.
— A single stock future. In effect stock futures share similar characteristics to CFDs but stock futures allow the transfer of the underlying asset on expiry (with CFDs, this isn’t normally possible).

It is worth noting that CFDs, spread bets and futures are all not subject to stamp duty as they don’t involve ownership of the underlying asset on which they are based. In this section we will find out more about CFDs, how they work and the differences between CFDs and other financial products.