CFD Forex Trading (Contracts for Difference)

CFDs are becoming more and more popular nowadays. The reasons of growing popularity are the following:

CFDs on US Stocks

Contract for Difference (CFD) is the agreement between two parts to exchange the difference between the opening value and the closing value of an instrument.

CFD is an example of margin trading which allows you to take more profit as you use the leverage. It means that an investor can buy CFD even if he doesn't have the whole value to purchase shares. For example, to buy the Microsoft shares at the amount of $10,000 you need a deposit of only $1,000. If you take a profit of $1,000 your return is 10% if you trade the underlined shares, but you have 100% of return if you trade CFD. But you must be aware that losses are calculated the same way.

We can say that contract for difference can be qualified as purchasing shares on the proceeds of the credit. If you trade CFD you get all the benefits of underlining share, including price rise and dividends, and pay off on-credit expenditures to the seller. It's a sort of a bank credit: you borrow money to buy shares and get the benefits of a shareholder and bank takes an interest. CFD presents this process as a single deal.

If you trade CFD you don't get dividends as real shareholders as you deal with "Dividend Adjustment". This means that on the day called ex-dividend date if you have open positions your account will be credited or debited to reflect those adjustments. If you have long position the adjusted amount is credited, if you have short position it is debited. Dividend adjustments are calculated at the same basis as share dividends. For more information about the dividends apply to the page: "Dividends for CFDs on shares".

Long position

You've decided to purchase the Microsoft shares, get the quotes 23.97/24.00 and buy 100 shares at 24.00. Then:

Microsoft share value $24.00 Number of shares 100 Contract size $2,400.00 Commission (0,1%) - $2.40 Margin (10%) $240.00

In order to make this deal you need $242.40 on your deposit.

Credit Settlements

Credit settlements are required when you leave your position open till the end of the trading session. Credit settlements are calculated with regard to FED funds rate (for US Stocks) and the end-of-the-day price of the share.

For example: FED Funds rate is 1.75%, and the closing price of the Microsoft share is 25.00. So, your credit settlements is 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

Three days later the value of Microsoft shares is 25.50/25.53 and you make a decision to close this position by selling the contract for difference at 25.50:

Microsoft share value $25.50 Number of shares 100 Contract size $2,550.00 Profit + $150.00 Commission (at closing there is no commission) $0.00 Credit settlements (3 days) - $0.84 Profit less commission and on-credit expenditures +$146.76 (+ 150.00 - 2.40 - 0.84)

The profit is 61% from the initial capital.

Contract details

CFDs on ETFs (also called index shares)

Nowadays it's becoming more and more popular to trade financial instruments, which are related to Stock Indices. Index investment means that you closely track the price and yield performance of any index. In order to do it you build you investing portfolio using instruments which track the index. These tools can help investor to build a diversified portfolio. But for small investors and traders it's hard to invest in NASDAQ 100 or S&P 500, because it's required to have more than one share of any company listed in these indexes. Recently only professional investors with million dollars portfolios could invest in indexes.

The first step in developing of this type of investment for small traders was made in 1993 when S&P unit investment trust was introduced. Known as "Spiders," a SPDR is a unit investment trust that holds shares of all of the companies in the Standard & Poor's 500 Composite Stock Price Index (S&P 500). The price of a unit in the trust is always the current value of the S&P 500 Index divided by 10.

Next step was made in 1997 when DIAMONDS, an index product based on the Dow Jones Industrial Average, appeared (DIA, trade around 1/100th of the value of the Dow). And then, in 1999 the Nasdaq-100 Trust was introduced (QQQ (Cubes), trade around 1\40 of the value of the Nasdaq 100) After that many investors got the opportunity to invest in indexes because they traded on stocks and as of 05\14\2003 the prices were:

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

Generally investors like trading Cubes, Diamonds and Spiders (catchy names from traders' jargon), as you don't have to be a market pro to understand and trade them. In fact their volumes are much higher than trading other stocks.

The main points you need to pay attention at:

1. The value of the share to the index is not fixed, as you need to use calculations, moreover it depends on the demand and supply.
   • 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. Value differentials of the shares and underlying indexes give a great opportunity for arbitrage. It is called "Program trading" because it's so widespread and computerized. Security and Exchange commission of US government controls American Stock Exchange and release the information of Program Trading value daily, usually it's not less than 30% of total value on the exchange.
3. Index trust shares are highly liquid. Day volume can be more than 100 mln. shares. At the beginning of 2002 the assets of stock exchange funds were more than $82 bln.
4. Dividends on SPY and QQQ shares are paid once a quarter and because of the listed companies the size is rather small. Dividends on DIA shares are paid on monthly basis.

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