CFDs

Guide: General Information

Different Types of CFDs

Flexibility

Trading in CFDs gives you the ability to establish a short position as easily as a long position. This can be done without the costs involved in dealing 'T+20' i.e. you do not have the costs of rolling over positions and commissions and stamp duty. In other words CFDs provide an easy way to take advantage of a negative view on a stock.

CFDs have no expiry date so positions can be run indefinitely (there may be exceptions in the case of smaller capitalisation stocks and residually settled stocks). Short positions also generate a cash balance from the sale of the stock, which the CFD provider passes on in the form of daily interest.

Gearing

As CFDs typically attract a margin rate of 20% (although this may be higher for stocks with lower liquidity and higher volatility), the client only needs to put up £20,000 to establish a position in £100,000 worth of, say, Marks & Spencer.

The client is responsible for maintaining enough funds in his account to provide the appropriate margin and any running losses to date, if applicable, so it is always prudent to leave a buffer of funds in reserve. In the above example, if the client opened an account with £20,000 and immediately bought 50,000 Marks & Spencer at 200p there would be little room for manoeuvre.

Ignoring funding and commission costs, and assuming that the stock closed unchanged at 200p, his net equity (see the FAQ section of this guide for an explanation of net and free equity) on his account would be £20,000 and his free equity would be zero. If the stock fell 5p the following day and closed at 195p, his net equity would be £17,500 and his free equity would be (£17,500- £19,500)= - £2,000. The client would be expected to provide £2,000 immediately, or alternatively to reduce his position. To avoid this inconvenience, the client would be better placed to establish a smaller position and leave funds in reserve for this eventuality.

So, if he had instead gone long a CFD in 40,000 Marks & Spencer at 200p which then fell to 195p, his net equity would be £18,000 and his free equity would be (£18,000-£15,600) = £2,400 and no fund movement would be necessary. Of course the gearing effect works both ways, and if the stock had risen as anticipated to, say, 205p, then in the first example the net equity would be £22,500 and free equity would be £2,000. This £2,000 in free equity would then be available for other positions. For this reason, the CFD equity product is only suitable for those with appropriate experience of trading with some kind of open-ended risk (such as writing options, spread-betting or margin trading).

Low cost execution

Retail commission rates are generally around 0.25% of the contract value, although traders who trade heavily and in size can expect more commercial rates. Under current legislation there is no stamp duty payable on CFD transactions. For short term traders these factors are significant. Indeed for traders who never run positions overnight, CFDs are clearly very effective. No stamp duty is payable or funding charges and only the commission costs and the spread are considerations in establishing and closing a position.

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