CFD’s – Futures
Most of Forex Brokers are offering you this type of products, that’s why we are making a short introduction on it.
CFDs are “financial contracts for difference.” They belong to the family of derivatives products as well as a certificate or a warrant, they allow to play both the rise or decline of one underlying. Unlike warrants, CFD cover much underlying and therefore they offer a wide variety of choices as well on gold, oil and a large number of currency pairs. It is important to note that the investor does not own the underlying and, as such, capital movements are not on the notional amount but on the difference between your purchase price and your selling price.
On the Forex, margin calls will be made at the end of each trading day if necessary. If the evolution of the underlying is negative for you, your broker will make a margin call to restore the full margin required. With the leverage at your disposal, your loss may be quickly abysmal. I would therefore caution against that. You must define your trading strategy, with an objective of profit and loss and deal with stop. The position can be closed as soon as you wish. Moreover, and this is a big advantage, CFDs have no expiry date and therefore have no time value.
The CFD does not lose value as time passes, as it is the case for warrants. So you can keep over a long period without having to worry about this factor. Finally, the CFD allow to not obeying at the law of the Market Maker as it is on certificate or warrant. Those who have played on this type of product are aware that often the product is influenced by the issuer who adjusts its prices. With CFDs, this can be avoided. Indeed, some brokers offer CFDs with a similar price to the underlying and so, MA cannot change the price to his liking. What is advantage to buy a CFD if its price replicates the underlying price, why not directly buy tge underlying? Again, the CFD has an advantage which is it is not subject to tax on capital profit because you do not physically possess the underlying.
Here a small summary of the advantage described above:
– Effect of leverage available
– No tax on capital profit on the sell
– No time value
– Possibility to trade a multitude of underlying
– Price not influenced by the Market Maker (according to the broker)
– Ability to play both, the upward and downward
A future contract is a forward contract. It is a commitment taken between a buyer and a seller, to exchange at a future date an underlying asset at a price determined in advance. It is the same as a forward foreign exchange. The contract is firm. Delivery dates are the 3rd Wednesday of March, June, September and December. The futures are traded on organized markets and you have to go through your broker to deal with them.
At the end of each day’s trading, margin calls will be made according to changes in the underlying. You could close your position when you wish. But the futures market is much less liquid than the spot market. Indeed, the contracts are standardized. The contract the most widespread is 125K. By dealing on contracts with a lower amount you might have a spread, which grows as liquidity reducing. It is however a great advantage when future liquidity allows it, there is no spread. This is explained simply. On futures, your broker is not your compensation unlike spot market. It just lets you connect with another investor. It takes just a fixed fee for this of around 2 Euros per contract, which is ridiculous. In the market of the future, we speak about contract rather than lots.
Importers and exporters of goods and services rely heavily on this technique to cover fluctuations over time.
Here a small summary of the benefits described above:
– No spread (Minimal transaction costs)
– Important effect of leverage due to the size of contracts
– Ability to play both, the upward downward
– No exchange of notional
– Allows to hedge against the rise or fall