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Introduction to CFDsEquity Contracts for Difference (CFDs) are growing rapidly in popularity and, for the experienced investor, are proving an attractive means of gaining exposure to the economic performance and cash flows of individual equities without the need to invest in the physical share. A CFD is a financial instrument linked to the underlying share price. Consequently, no rights are acquired or obligations incurred relating to the underlying share and, depending on your view of a companys share price, you can buy (go long) or sell (go short). The ability to go short is one of the principal attractions of CFDs as other methods of going short are both expensive and inconvenient.
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Some Questions and Answers Q1. What is an Equity Contract for Difference ? A. An Equity Contract for Difference is an agreement (made between two parties) to exchange, at the closing of the contract, the difference between the opening and closing prices, multiplied by the number of shares detailed in the contract. Q2. What is the Contract Value ? A. Every CFD has a Contract Value. It is the number of shares in the contract multiplied by the price of the underlying share. The Contract Value will change in line with the changes in the price of the underlying share. A CFD is marked-to-market (i.e. valued) daily at the close of business mid-price of the underlying share. Q3. Do I have to pay the full Contract Value of Equity CFDs ? A. No, an Equity CFD is a Margined Transaction. Q4. What is a Margined Transaction? A. A Margined Transaction is a transaction where the deposit of cash or other acceptable security (the Margin) is required to secure the performance of the obligations under the contract Q5. What Margin is required for an Equity CFD ? A. CFDs can be traded by providing Margin from 10% of the Contract Value. For example, if you want to open a CFD with a Contract Value of £25,000 you will be required to deposit £2,500. (If you are trading in an overseas market or one that has a history of price volatility the Margin required may be higher). The margin required may fluctuate from day-to-day in line with changes in the close of business price of the underlying share. Q6. Can I buy or sell an Equity CFD ? A. Yes. You can buy (go long) a CFD and will make a profit if the value of the CFD increases. Conversely, if you sell (go short) a CFD you will make a profit if the value of the CFD decreases. The ease with which a short position can be established with a CFD is one of major attractions. It can be done without incurring the costs involved in dealing on a T+20 basis, i.e. there are no commission charged or Stamp Duty incurred in rolling positions forward. Consequently, CFDs provide an easy way to take advantage of a negative view on a share. The examples below illustrate the features of long and short trades and compare them to traditional equity investments. Q7. Why and how frequently is interest charged or credited ? A. When going long a CFD the economic aspects of a conventional share purchase are replicated. Accordingly, interest, calculated on a daily basis, on the Contract Value will arise. On the other hand, with a short CFD position, a conventional share sale is simulated and interest, also calculated on a daily basis, will be earned. Whether you are long or short the interest calculation is based on the day-to-day Contract Value is usually applied to the account weekly in arrears. Interest is typically calculated at a margin above or below the relevant Inter-Bank Offered Rate for long and short positions respectively. The applicable rates will be notified in writing on opening the account. Q8. What happens when a company pays a dividend? A. The holder of a long CFD will receive, on the ex-dividend date, a payment that equates to the net dividend (i.e. having deducted UK basic rate tax) on the underlying share. This payment will be credited to the account. A short CFD holder will, on the ex-dividend date be charged the gross dividend by way of a debit to the account. Q9. Will I have to pay Stamp Duty when buying Equity CFD's ? No. As no purchase of the underlying shares is involved no Stamp Duty (currently 0.5% of the Contract Value) is payable. Truncated... extract is from Sucden UK detailed CFD notes. Click HERE For the full article
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