10 Contracts for Differences (CFDs)
10.1 History
Section titled “10.1 History”CFDs emerged in the UK in the 1990s from equity-swap-style products and reached retail markets in the late 1990s; they were not available in the US retail market in the same way. That history explains their OTC, leveraged and cash-settled character.
10.2 Definition
Section titled “10.2 Definition”A CFD is an agreement to exchange in cash the difference between the opening and closing value of an underlying position (or the reverse for a loss). The investor does not own the share/asset, normally has no voting rights, and does not take physical delivery. Long equity CFDs may receive a dividend adjustment; short positions may be debited. Corporate-action adjustments follow the provider’s terms.
10.3 Characteristics
Section titled “10.3 Characteristics”Leverage, flexibility, relatively low initial outlay, transparent reference price, simplicity of long/short exposure, no fixed expiry in some provider models, global access, cash settlement and corporate-action adjustments are key features. Countervailing risks are margin calls, forced liquidation, financing, commission/GST, rollover, spread, provider credit and market liquidity.
CFD terms include underlying, opening/closing price, number of units, direction, currency, margin, financing rate, expiry/rollover and corporate-action treatment.
10.4 Business models
Section titled “10.4 Business models”- Market maker: provider quotes the CFD and may internalise/hedge flow; price and spread depend on its ability and discretion.
- Direct market access (DMA): orders route through the provider to the underlying market; DMA is predominant in Singapore.
- Exchange-traded CFD: exchange/clearing structure can reduce bilateral counterparty risk but remains product-specific.
10.5 Advantages
Section titled “10.5 Advantages”CFDs allow long or short access to shares, indices, sectors, FX, commodities, government treasuries, ETFs, VIX/volatility references, real estate and other global instruments from one account, with a smaller initial cash outlay and no need to own/borrow the underlying in the same way as a cash trade. They can be used for hedging, tactical exposure, pairs trading and dividend capture.
10.6 Mechanisms
Section titled “10.6 Mechanisms”10.6.1 Opening and margin
Section titled “10.6.1 Opening and margin”Initial margin is a percentage of contract value. The investor controls a larger notional than the cash posted; return on margin can be high but losses are based on the full exposure. Maintenance margin and provider limits apply. The Risk Disclosure Statement (RDS) should explain margin, liquidation and the client’s liability.
10.6.2 Mark-to-market and margin calls
Section titled “10.6.2 Mark-to-market and margin calls”Positions are revalued as the underlying moves. A margin call requires additional funds; if not received, the provider may sell some or all positions. The investor remains liable for a shortfall, loss and expenses after liquidation. A stop-loss is not a guarantee against gap/slippage.
10.6.3 Financing and corporate actions
Section titled “10.6.3 Financing and corporate actions”Long CFDs normally incur interest on the full notional; short CFDs may receive interest on deferred sale proceeds but can incur stock-borrow costs. Commissions are commonly a percentage of notional subject to a minimum; GST may apply. Rollover fees depend on provider and asset. Long equity positions may receive cash dividends; short positions pay them. Splits/reverse splits adjust quantity/price; scrip dividends, bonus and rights entitlements may differ or require close-out.
10.6.4 Orders and stops
Section titled “10.6.4 Orders and stops”All orders are day orders unless otherwise stated and use the underlying bid/ask. Limit orders transact at the stated price or better. MTL orders execute at the market and leave an unfilled balance at the prior execution price. Market orders execute at the best available bid/ask. Stop-loss and stop-entry orders activate at a trigger; fast markets can gap through the stop. A guaranteed stop, if offered, is a distinct paid service.
10.6.5 Cost examples
Section titled “10.6.5 Cost examples”Worked example. Buy 10,000 shares at $2, sell after 10 days at $2.20, with 0.4% commission, 8% GST on commission and 5% annual financing. Buy commission/GST = $86.40; sell = $95.04; ten-day financing = $27.78; total expense = $209.22; net profit = $1,790.78.
Short example: sell 10,000 at $3.30, cover at $3.10, 0.4% commission, 8% GST, 20% margin and 6% financing for five days. Total expense = $303.98; net profit = $1,696.02; capital posted = $6,600; ROI ≈25.70%. If the price rises to $3.45, expense = $319.10; net loss = $1,819.10; ROI ≈−27.56%.
10.6.6 CFD versus futures
Section titled “10.6.6 CFD versus futures”CFDs are mostly OTC, can be extended/rolled subject to provider policy, explicitly charge financing, may pass dividend adjustments and carry provider counterparty risk. Equity futures are exchange-traded, have fixed expiry, embed financing in the price, normally have no dividend entitlement and are also margined/leverage products.
10.7 Global trading opportunities
Section titled “10.7 Global trading opportunities”Underlyings include Singapore STI/SiMSCI and global equity/sector indices (S&P 500, DJIA, FTSE100, CAC40, DAX, Nikkei225, ASX200, Hang Seng, China A50), currencies (AUD, CAD, EUR, CNH, JPY, CHF, GBP, USD), energy/industrial/precious metals/agricultural commodities, US/UK/Japan/Euro government bonds, ETFs such as SPDR Gold and volatility/real-estate references. Availability is provider-specific.
10.8 CFD trading strategies
Section titled “10.8 CFD trading strategies”- Dividend capture/stripping: buy before ex-dividend and close after, seeking to benefit if the price does not fall by the full dividend; costs, tax, timing and price behaviour can defeat the trade.
- Pairs trading: long an undervalued/stronger asset and short an overvalued/weaker related asset. It aims for mean reversion and market neutrality but correlation can break and costs double.
- Industry-sector pairs: compare companies such as property stocks; stock-specific and sector risks remain.
- Statistical arbitrage: use historical correlation/quantitative signals; a relationship may not revert.
- Merger arbitrage: long target/short acquirer or the reverse; deal failure can hurt both legs.
- Index pairs: trade correlated indices such as S&P500 and Nikkei225 when their relationship diverges; index liquidity is usually deeper than single stocks.
10.9 Summary
Section titled “10.9 Summary”CFDs are leveraged cash-settled contracts, not ownership. Their flexibility hides financing, margin, liquidation, counterparty, liquidity, currency, corporate-action and short-sale risks. Learn the provider model, order mechanics, total cost and worst-case liability.