Pricing of CFD
CFDs are traded between individual traders and CFD providers. There are no standard contract terms for CFDs, and each CFD provider can specify their own, but they tend to have a number of things in common.
The CFD is started by making an opening trade on a particular instrument with the CFD provider. This creates a ‘position’ in that instrument. There is no expiry date so the position is closed when a second reverse trade is done. At that point the difference between the opening trade and the closing trade is paid as profit or loss. The CFD provider may make a number of charges as part of the trading or the open position. These may include, bid-offer spread, commission, overnight financing and account management fees.
Even though the CFD does not expire, any positions that are left open overnight will be ‘rolled over’. This typically means that any profit and loss is realised and credited or debited to the client account and any financing charges are calculated. The position then carries forward to the next day. The industry norm is that this process is done at 10pm UK time.
CFDs are traded on margin, and the trader must maintain the minimum margin level at all times. A typical feature of CFD trading is that profit and loss and margin requirement is calculated constantly in real time and shown to the trader on screen. If the amount of money deposited with CFD broker drops below minimum margin level, margin calls can be made. Traders may need to cover these margins quickly otherwise the CFD provider may liquidate their positions.
To see how CFDs work in practice see the examples of typical CFD trades. The ‘margin percentage’, and ‘charges’ shown may vary from provider to provider, but are typical of CFD providers.
Charges
The contracts are subject to a daily financing charge, usually applied at a previously agreed rate linked to LIBOR or some other interest rate benchmark e.g. Reserve Bank rate in Australia. The parties to a CFD pay to finance long positions and may receive funding on short positions in lieu of deferring sale proceeds. The contracts are settled for the cash differential between the price of the opening and closing trades. Traditionally, equity based CFDs are subject to a commission that is a percentage of the size of the position for each trade. Alternatively, a trader can opt to trade with a market maker, foregoing commissions at the expense of a larger bid/offer spread on the instrument.
Margin
Traders in CFDs are required to maintain a certain amount of margin as defined by the brokerage or market maker (usually ranging from 0.5% to 30%). One advantage to traders of not having to put up as collateral the full notional value of the CFD is that a given quantity of capital can control a larger position, amplifying the potential for profit or loss. On the other hand, a leveraged position in a volatile CFD can expose the buyer to a margin call in a downturn, which often leads to losing a substantial part of the assets. CFDs allow a trader to go short or long on any position using margin. There are always two types of margin with a CFD trade:
- Initial Margin - (normally between 3% and 30% for shares/stocks and 0.5% - 1% for indices, foreign exchange and commodities)
- Variation Margin - (which is then 'marked to market').
Initial margin is fixed at between 0.5% and 30% depending on the underlying product and overall perceived risk in the market at that time. For example, during and after 9/11 initial margins were massively hiked across the board to counter the explosion in volatility in the world's stockmarkets.
