Contracts For Difference (CFDs)
• If you buy £10,000 of Vodafone stock through your stockbroker you will have to deposit £10k in funds, but if you do the same trade using a CFD only 10%-20% of the nominal amount is needed i.e. your buying power has increased by 10%-20%.
• This means that CFDs are geared investments in that profits and losses are multiplied considerably due to the nature of controlling the asset with a reduced amount of capital
CFDs are therefore designed to appeal to the stockmarket trader rather than the investor. Day-traders, short term traders, people who look for share price moves of between 1-20 days utilise them heavily especially as they can easily be used to short stocks, so enabling money to be made of falling prices.
Dealing CFDs is almost exactly the same as using a traditional stockbroker to buy or sell shares, including the same dealing price (except the CFD brokers who offer commission free dealing). Look at this example.
• Two traders, Trader A & B, both believe that HBOS Bank will rise over the next few days
• Trader A will do the trade through his regular stockbroker
• Trader B will use Contracts for Difference
Trader A Uses a Stockbroker
• He calls his stockbroker at 11am and asks the current market quote for HBOS
• The broker quotes him £7.49 - £7.50
• He buys 1,000 shares at £7.50 and pays regular commissions and Stamp Duty (0.5%)
• He calls his CFD broker also at 11am asking for a quote on HBOS
• The CFD broker quotes him the same price £7.49 - £7.50
• He buys 1,000 shares using CFDs at £7.50
• He pays commission on the deal but NO Stamp Duty (not levied for CFD transactions)
Who Owns The Shares In A CFD Transaction?
• Trader B's CFD broker quotes him a market of £7.49 - £7.50 in HBOS
• He sells short 1,000 shares at £7.49
• 3 days later he buys the shares back at £7.29 making a profit of 20p per share or £200 excluding commissions
1. The share price can go up
2. The company can pay a dividend
3. The shares can be lent (for a small fee) to another financial institution, in this case a CFD broker
• These shares are then sold in the market
• When Trader B decides to cover his short position (whether at a profit or loss) he buys 1,000 shares which are then returned to the original owner
• It's a win-win-win for all three parties involved
• The trader has the ability to short, the CFD broker earns commission and the Fund Management company earns a small fee for lending the stock (this fee is normally taken care of by the CFD financing rates)
NOTICE: If received in error, please destroy and notify sender. Sender does not waive confidentiality or privilege, and use is prohibited.