Jump to navigation Jump to search “CFDs” redirects here. CFDs are available in Australia, Austria, Canada, Cyprus, Czech Republic, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, The Netherlands, Luxembourg, Norway, Utrade forex exchange, Portugal, Romania, Russia, Singapore, South Africa, Spain, Sweden, Switzerland, Turkey, United Kingdom and New Zealand.
CFDs were originally developed in the early 1990s in London as a type of equity swap that was traded on margin. In the late 1990s CFDs were introduced to retail traders. They were popularized by a number of UK companies, characterized by innovative online trading platforms that made it easy to see live prices and trade in real time. Around 2000, retail traders realized that the real benefit of trading CFDs was not the exemption from tax but the ability to leverage any underlying instrument. This was the start of the growth phase in the use of CFDs.
Around 2001 a number of the CFD providers realized that CFDs had the same economic effect as financial spread betting in the UK except that spread betting profits were exempt from Capital Gains Tax. Most CFD providers launched financial spread betting operations in parallel to their CFD offering. CFD providers then started to expand to overseas markets, starting with Australia in July 2002 by IG Markets and CMC Markets. As a result, a small percentage of CFDs were traded through the Australian exchange during this period. The advantages and disadvantages of having an exchange traded CFD were similar for most financial products and meant reducing counterparty risk and increasing transparency but costs were higher. The disadvantages of the ASX exchange traded CFDs and lack of liquidity meant that most Australian traders opted for over-the-counter CFD providers.
CFDs to avoid them being used in insider information cases. Clearnet in partnership with Cantor Fitzgerald, ING Bank and Commerzbank launched centrally cleared CFDs in line with the EU financial regulators’ stated aim of increasing the proportion of cleared OTC contracts. The main risk is market risk, as contract for difference trading is designed to pay the difference between the opening price and the closing price of the underlying asset. CFDs are traded on margin, and the leveraging effect of this increases the risk significantly. If prices move against open CFD position additional variation margin is required to maintain the margin level.
The CFD providers may call upon the party to deposit additional sums to cover this, and in fast moving markets this may be at short notice. Counterparty risk is associated with the financial stability or solvency of the counterparty to a contract. This section possibly contains original research. There are a number of different financial instruments that have been used in the past to speculate on financial markets.
These range from trading in physical shares either directly or via margin lending, to using derivatives such as futures, options or covered warrants. A number of brokers have been actively promoting CFDs as alternatives to all of these products. A number of people in the industry back the view that a third of all LSE volume is CFD related. Easy to create new instruments, not restricted to exchange definitions or jurisdictional boundaries, very wide selection of underlying instruments can be traded. Professionals prefer futures for indices and interest rate trading over CFDs as they are a mature product and are exchange traded. The main advantages of CFDs, compared to futures, is that contract sizes are smaller making it more accessible for small trader and pricing is more transparent.
Futures are often used by the CFD providers to hedge their own positions and many CFDs are written over futures as futures prices are easily obtainable. CFDs don’t have expiry dates so when a CFD is written over a futures contract the CFD contract has to deal with the futures contract expiry date. Options, like futures, are an established product that are exchange traded, centrally cleared and used by professionals. Options, like futures, can be used to hedge risk or to take on risk to speculate.
CFDs are only comparable in the latter case. The main advantage of CFDs over options is the price simplicity and range of underlying instruments. Compared to CFDs, option pricing is complex and has price decay when nearing expiry while CFDs prices simply mirror the underlying instrument. CFDs cannot be used to reduce risk in the way that options can. Similar to options, covered warrants have become popular in recent years as a way of speculating cheaply on market movements. CFDs costs tend to be lower for short periods and have a much wider range of underlying products.
In markets such as Singapore, some brokers have been heavily promoting CFDs as alternatives to covered warrants, and may have been partially responsible for the decline in volume of covered warrant there. This is the traditional way to trade financial markets, this requires a relationship with a broker in each country, require paying broker fees and commissions and dealing with settlement process for that product. With the advent of discount brokers, this has become easier and cheaper, but can still be challenging for retail traders particularly if trading in overseas markets. Without leverage this is capital intensive as all positions have to be fully funded. Margin lending, also known as margin buying or leveraged equities, have all the same attributes as physical shares discussed earlier, but with the addition of leverage, which means like CFDs, futures, and options much less capital is required, but risks are increased. Some financial commentators and regulators have expressed concern about the way that CFDs are marketed at new and inexperienced traders by the CFD providers. In particular the way that the potential gains are advertised in a way that may not fully explain the risks involved.