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Equity Contracts for Difference or CFDs have grown rapidly in popularity in recent years 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 and sold as a contract. No rights to the shares are acquired or obligations incurred relating to owning the share although dividends are accrued or debited depending on the CFD type held.
Depending on your view of a companys share price and prospects, you may buy with a CFD (go long) or sell with a CFD (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.
A CFD is also a margined transaction and requires only a deposit of cash to make a contract and not the full price that you would pay if you were actually buying and holding the shares. Interest is charged though daily, based on contract value until the date of sale.
It should be noted that CFD's are derivative products and carry a high level of risk. It is possible, if markets move against you, that you may loose more than your original deposit. As such, CFD's are not suitable for inexperienced traders.
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.
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.
A. No, an Equity CFD 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.
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.
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.
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.
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.
No. As no purchase of the underlying shares is involved no Stamp Duty (currently 0.5% of the Contract Value for a share purchase) is payable.
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