Contracts for Difference (CFDs)

What are Contracts for Difference

We specialize in Contracts for Difference (CFDs). Contracts for Difference are an over-the-counter contract between two parties to exchange at the close of the contract the difference between the opening and closing price of the underlying asset multiplied by scale of trade specified in the contract. The Client sets the size of the contract and chooses when the contract expires by virtue of their decision to close the contract. The client has access to global commodities, equities, indices, and can trade globally from their Canadian Account.

CFDs are available on Foreign exchange, Equity indices, single name equities, Commodities and Exchange Traded Funds allowing your CFD investments to cover the spectrum of investments from a single platform.

While the economic performance of the CFD is directly driven by the price of the underlying asset, there is no right or requirement to acquire or deliver the underlying. Traders have long struggled with the ability to short stocks or indices, and not run the risk of physical delivery as in futures – CFDs are the answer.

History of CFDs

CFDs were originally developed in the early 1990′s by the derivative desk of Smith New Court – a London based trading firm. CFDs enabled the firm’s hedge-fund clients to easily sell short in the market (the London Stock Exchange) with the benefit of leverage, and to benefit from stamp duty exemptions that were not available to outright share transactions. By using CFDs, these large clients no longer needed to physically settle their equity/share transactions. They were also able to avoid the need to borrow stock when they wanted to sell short.

It is worth noting that at first, contracts for difference were only available to large corporations, but by the mid 1990s, they became popular with hedge-fund traders who wanted to take advantage of the ups and downs of the market.

In the late 1990′s CFDs were introduced to private clients and the retail market by Gerrard & National Intercommodities (GNI – now part of the Man Group plc) via its online trading arm – GNI Touch. GNI offered its clients CFD products and an innovative trading system that allowed private clients to trade via the Internet directly into the London Stock Exchange – the CFD revolution was born and by the end of the decade, CFDs had become widely available in the U.K.

Individuals trading their own accounts, small fund managers and institutions were now able to trade directly into the London Stock Exchange for the first time. These clients were now on a level playing field with the large institutions. They were able to take leveraged long (bought) positions and short (sold) positions without having to take delivery of the underlying shares.

CFDs Globally

CFDs are a global derivative currently available in over-the-counter markets in the United Kingdom, Germany, Switzerland, Italy, Singapore, Thailand, South Africa, Australia, New Zealand, Hong Kong, Sweden, Norway, Belgium, Denmark, Netherlands, France and Spain and the US (to non-residents only) , as well as Canada.
Contracts for Difference (CFDs) are today one of the fastest growing tools in the financial services industry for trading in a range of markets including shares, global market indexes, Forex, and commodities.

Market participants from all backgrounds and levels of experience are now harnessing the power of CFDs to increase their returns, better manage their risk, and develop their trading strategy and skill.

The explosion in the use of this product is one of the reasons why London over the last few years, as opposed to New York, has become the financial location of preference for many financial managers and hedge funds. The U.S. Securities and Exchange Commission do not allow contracts for differences in the US because of legal restrictions on OTC financial instruments. Canada has no restriction.

At the moment CFDs represent a small but rapidly growing portion of Canadian equity trading. In the UK for example, The London Stock Exchange believe CFD activity equals 30% of daily FTSE volume. In Australia CFD’s account for around 15% of daily ASE volume. Average Daily FX turnover in CAD/US in Q4 2009 was in excess of $70billion/day, yet most Canadian Investors struggle to take part in this huge market place.

Index-Tracking CFDs

Index CFDs are also available that allow effective trading of 20 major indices. Index CFDs have low margin requirements (leverage your investments up 20 times) and offer all the trading advantages of Stock CFDs, including short selling.

No Commissions on FX, Indices & Commodities

Commissions are built into the trading spread for convenience and making it easier to calculate actual profit/loss on positions. In most cases, this is the only fee you pay, and the advantage is that the running profit or loss calculation on a position always includes trading fees.

Trade share CFDs on Live Prices

The client trades CFDs on Shares at the underlying exchange price- commissions associated with the transaction are added post trade. ( see Margins Commissions & Costs).

Benefits of CFDs

CFDs give a trader easy access to global financial markets through a single account, and single trading platform with none of the headaches of different brokerage accounts global custody or settlement issues. CFDs allow a client to participate in the trading dynamics of a plethora of financial instruments without the burdens of ownership or delivery headaches which plague futures traders. The ability to short assets, and parcel pairs of trades together, with easy to use interfaces and clear risk and P&L parameters and measurement, make trading the world a breeze.

Margin Trading

Magnify small intra-day price swings by depositing only a fraction of the trade value in collateral (from as little as 5%). Tradestone Markets allows you to leverage stock and index CFD investments up to 20x (5% margin requirement) where an investment of only  $10,000 can be used to command a CFD position of up to  $200,000 in the market.

CFD Interest & Accrual Rates

If you hold a CFD after the stock market closes, you are subject to a financing fee or accrual:

  • When you buy a CFD, you are subject to a financing charge at the Inter-Bank Offer Rate for the currency in which the share is traded (e.g. LIBOR plus 3%)
  • When you short sell a CFD, you receive an interest accrual at the Inter-Bank Bid Rate for the currency in which the share is traded (e.g. LIBID minus 2.5%)
  • If you open and close a CFD position within one trading day, you are not subject to these charges or accruals.

Currency Conversions

Currency conversions of trading costs as well as profits and losses from trading activities are done using the prevailing close rate as of 17:00 New York Time, plus/minus one half of one percent ( 0.5%)

Short Selling CFDs

When short selling a CFD directly on an exchange, you will be affected by the rules for the stock market in that country. For example:

  • For US CFDs, an up-tick rule applies where you can only short sell on an up-tick
  • For Australian CFDs, you may experience limitations on the amount of CFDs you can short trade in a single day due to limited borrowing availability in the underlying market
  • When short selling CFDs, you can experience forced closure of a position if your CFDs get recalled. The risk is particularly high if the stock becomes hard to borrow due to takeovers, dividends, rights offerings (and other merger and acquisition activities) or increased hedge fund selling of the stock.

Dividends on CFD Positions

Holders of long CFD positions will, when dividends are paid on the underlying share, qualify for a proportional payout. Holders of short CFD positions will have to pay an amount equal to the full (gross) dividend paid on the underlying share.

The amount will be credited/debited your trading account on ex-date, unless the dividend rate is unconfirmed in which case the dividend is paid on pay date (e.g. ADR’s).

Dividends on CFD positions are are cash adjustments paid and debited by Tradestone and not by the underlying company. Dividends paid on CFDs are not eligible for any preferential withholding tax rates sometimes associated with dividends paid on physical stocks and may therefore differ from the dividends payable on the underlying share.

Partial Fills

Partial fills may occur on limit orders and the remaining amount stays in the market as a limit order and may be filled within the order duration.

Market orders can be filled at numerous levels, the price paid will be the volume weighted average price of all the fills.

Pricing, Spreads and other important information

Tradestone Markets quotes a price in a security, commodity or Foreign exchange pair with a bid price and an offered price. The Bid or “sell” price  is quoted first and the Offer or”buy” price is quoted second. The difference between the two prices is called the Bid to Offer “spread”. If a client thinks the security is going to rise in price, they would use the “Buy” or Offered side price. If the client thinks the security is going down in value they would use the “sell” or Bid price. As such professionals use the term hitting the Bid for selling and lifting the Offer for buying.

In Currency pairs, if a client is looking at USD/EUR if they sell on the Bid price they believe USD are going to lose value relative to EUR, if they believe the USD is going to rise in value they would buy USD on the Offer or buy price. As such, if a client is worried about the Canadian$ being overvalued, when the client looks at USD/CAD they want to buy USD, as such the client would trade on the Offer or “Buy” price side of the pair, so that they end up owning USDs and are Short ( have sold) Canadian dollars.

CFD Trade Example

A client wants to Buy 1,000 Toronto Dominion Bank share CFDs.

TD is quoted on the TSX 74.19/74.20

TD is margined at 15%

The client must have margin in his a/c of $11,130 to Buy 1,000 TD share CFDs

1,000 x $74.20 x 0.15 = $11,130

The client Buys 1,000 TD CFDs at 74.20 and pays $15 commission ($0.015/shr)

1 week later TD is quoted 76.75/76.76 and the client decides to take profit.

Client Sells 1,000 TD CFDs at 76.75 and pays $15 commission

Financing the position for 7 days costs $49.80

0.035* x $74,200 x 7/365 = $49.80
Total cost of transaction = $79.80

Gain = $76,750 – $74,200 = $2,550

Net profit = $2550- $79.80 =$2,470.20

This equates to a 22.2% return vs the margin employed for a 3.4% move in the underlying stock.

*The financing rate