CFD (Contracts for Difference)

The popularity of CFDs grows steadily these days due to the following reasons:

CFDs on US Stocks

CFD or Contract for Difference is the contractual agreement that is concluded between two sides in order to exchange the difference between a certain opening value and a certain closing value of an instrument. It is also a good example of margin trading, developed to bring you more profit when you use the leverage. An investor can afford to buy CFD even in the case when he doesn’t have the whole value needed for shares purchasing. For example, when you want to buy the Microsoft shares, the amount of which is approximately $10,000 you need to have a deposit of just $1,000. If you receive a profit in the amount of $1,000, you will be able to receive 10% if you do the underlie shares trading. Though if you trade CFD, you will receive 100% of your profit – but, of course, your possible losses will be calculated the same way.

It is possible to characterize the contracts for difference as the share purchase on the credit proceeds. This means that if you trade CFD you receive all possible benefits of the share (including dividends and price rise) and then you will have to pay off all on-credit expenditures to the seller you work with. It reminds of a bank credit as you borrow some money in order to purchase shares and receive all shareholders’ benefits and bank itself takes an interest. CFD describes this agreement as a single deal.

Though, unlike real shareholders in case of CFD trading you don’t receive dividends. That happens because you work with “Dividend Adjustment”: on the day that is described as ex-dividend date you will have your account credited or debited (depending on what position you have – long or short) in order to mirror those adjustments. These adjustments are calculates just the same way as ordinary share dividends. If you want more information about the dividends, you should look for it heree: "Dividends for CFDs on shares".

Long position

For example, you want to buy Microsoft shares, receive the quotes 23.97/24.00 and then purchase 100 shares at 24.00. Then:

Value of Microsoft shares $24.00 Number of shares 100 Size of the contract $2,400.00 Commission (0,1%) - $2.40 Margin (10%) $240.00

As you see, you need to have $242.40 on your deposit to perform this operation.

Credit Settlements

If you want to leave a certain position open until the very end of the trading season, you will require some credit settlements. For US Stocks they are calculated with regard to FED funds rate and the price of a certain share by the end of the day. When we take FED Funds rate of 1.75% as the example and also add the closing price of the Microsoft share that is, for example 25.00, you can have your credit settlements calculated the following way:

N_Stocks x P_Close x Interest / N_Days =
= 100 x $25.00 x (1.75% + 1.25%) / 360 =
= $0.28

Close a position

Let’s say that after three days the value if Microsoft shares become 25.50/25.53 and you decide to close this position by selling your contract for difference at 25.50:

Value of Microsoft shares $25.50 Number of shares 100 Size of the contract $2,550.00 Profit + $150.00 Commission (there isn’t any at closing) $0.00 Credit settlements (for 3 days) - $0.84 Profit less commission and on-credit expenditures +$146.76 (+ 150.00 - 2.40 - 0.84)

This way you will receive the profit of 61% from starting capital.

Contract details

CFDs on ETFs (another name for them is index shares)

Trading of financial instruments related to Stock Indices is becoming more and more popular these days. You have to pay attention to the price and yield performance of a certain index to engage into index investment. So your investing portfolio has to be built with the help of instruments that allow tracking the index – they can be of a great help if you want to create a diversified portfolio. Though, it is really complicated for small traders and investors to invest in shares of S&P 500 or NASDAQ 100 due to the requirement to have more than one share of any company that is listed in these main indexes. Due to that fact lately only professional investors could afford to invest in these indexes.

The first step towards this kind of investment developed for small traders was made in 1993: back then the S&P investment trust was introduced for the first time. A SPDR also known as “Spiders” holds shares of all the companies included into S&P 500. One unit of this trust costs the current value of S&P 500 index that is divided by 10.

Another step was made in 1997: an index product based on the DJIA, known as Diamonds appeared. Later, in 1999 the Nasdaq-100 introduced its trust named QQQ (Cubes). After the presentation of these trusts a lot of investors finally received an opportunity to invest unto these indexes. As of 05\14\2003 the prices were the following:

• SPY - $94.71,
• DIA - $87.04,
• QQQ - $28.66.

In general investors enjoy trading Diamonds, Spiders and Cubes as they don’t require you to be a professional on a stock market to trade and understand them. Moreover, their volumes are usually much higher than trading other stocks.

You need to focus on the following main points:

1. 1. There is no fixed value of the share to the index and you have to calculate it. It depends on the supply on the demand.
   • SPY - 1/10 of the value of S&P 500;
   • DIA - 1/100 of the value of DJIA 30;
   • QQQ - 1/40 of the value of NASDAQ 100.
2. The differential of value of underlying indexes and shares give traders a perfect opportunity for arbitrage. Due to its computerization and wide spreading this process is named “Program trading”. American Stock Exchange is controlled of Security and Exchange commission of US, providing traders with daily releases of Program Trading information, which is normally not less than 30% of total exchange value.
3. Day volume of index trust shares can reach more than 100 million shares and at the beginning of 2002 stock exchange funds assets reached over $82 billion.
4. Traders receive dividends on QQQ and SPY share once a quarter and the size of them is rather small due to the listed companies. And investors receive DIA shares once a month. All of the points listed above allow even small investors that aren’t well-informed about each company’s fundamentals use these great tools for investing.

All that makes it possible for the small investor who is not so sophisticated in fundamentals of each company to use these excellent tools for investing.

Contract details