How CFDs Differ from Spread Betting

Both contracts for difference (CFDs) Dan spread betting are forms of financial derivative trading. Derivative trading involves speculating on the future price action of an asset via the buying and selling of derivative contracts. It does not involve ownership of the asset. You can trade derivatives across various financial markets, such as forex, indices, commodities and shares. Although both CFDs and spread betting are leveraged products, they differ in significant ways. This article will explore these similarities and differences in depth.

What are CFDs?

Contracts for difference (CFDs) are financial derivatives, allowing traders to speculate on the price movements, both upward and downward, of underlying financial instruments. As CFDs are margined products, you can open a relatively large position using a small amount of capital and therefore can win or lose significantly more than you deposit initially.

 A CFD is an agreement between two parties: the trader (the buyer) and the broker (the seller). The contract states that the seller will pay the buyer the difference between the current value of the underlying asset (such as shares, currencies, commodities, indices, etc.) and its value when the contract is closed. If the asset’s price increases, the seller pays the buyer the difference. If the price decreases, the buyer pays the seller.

CFDs do not involve ownership of the physical asset or securities. Instead, they represent a tradable financial contract between a client and a broker who are exchanging the difference in the asset’s price from the opening to the closing of the contract.

What is spread betting?

Spread betting (also known as financial spread betting or FSB) allows investors to speculate on the price movements of various financial instruments, such as saham, Petunjuk, currency pairs atau commodities. Essentially, investors place bets on whether the market price will rise or fall from the time their bet is placed.

Investors can also determine the amount they want to risk on their bet. Spread betting is commission-free and allows investors to speculate in both rising and falling markets.

Spread-betting companies provide buy and sell prices to investors, allowing them to place bets based on their market prediction. Therefore, two prices are quoted for spread bets, the ‘bid price’ at which you can buy and the ‘ask price’ at which you can sell. The difference between the two prices is known as the ‘spread’.

Investors use the buy price if they expect the market to rise, or the sell price if they anticipate it to fall. Unlike traditional investing, spread betting is a form of betting rather than investing. However, it differs from fixed-odds betting, as it does not rely on a specific event occurring.

You can close the bet at any time to secure profits or limit losses.

Similarities of CFDs and spread betting

Leveraged products

Both CFDs and spread bets are leveraged products that derive their value from an underlying asset, without requiring ownership of the underlying assets. When trading contracts for difference, you speculate on whether the value of the underlying asset will rise or fall in the future. Both products allow you to open positions and gain market exposure with leverage, requiring only a small margin.

Going long and short

CFD providers offer contracts that allow both long and short positions based on the prices of the underlying assets. You take a long position when you expect the price to increase and a short position when you expect the price to decrease. In both situations, your aim is to profit from the difference between the closing and opening values.

Similarly, in spread betting, the spread is the difference between the buy and sell prices quoted by the spread betting company. The asset’s price movement is measured in basis points, allowing you to take long or short positions.

Trade on a wide range of markets

Both CFDs and spread bets offer opportunities to go long or short on a diverse range of markets, including forex, indices, stocks and commodities.

Margin requirements

In both CFD trading and spread betting, a small margin is required as an initial deposit, normally ranging from 5% to 20% of the value of the open positions. More volatile assets generally require higher margin rates and less risky assets require lower margins.

Although you contribute only a small percentage of the asset’s value in both CFD trading and spread betting, you are entitled to the same gains or losses as if you had paid 100% of the value of the position. However, CFD providers or spread betting companies may require you to make a second margin payment later on.

Managing risk

While you can never completely avoid risk when trading or investing, it’s your responsibility to make strategic decisions to minimise significant losses. In both CFD trading and spread betting, potential profits can match 100% of the underlying market’s movements, but potential losses can also reach the same level.

To manage risk, you can set a stop-loss order before entering a contract in both CFDs and spread bets. A stop loss is a predetermined price level that automatically triggers the closure of the contract when the price is reached. To ensure stop-loss orders are executed, certain CFD providers and spread betting companies offer guaranteed stop-loss orders at a premium price.

Key differences between CFDs and spread betting

Fixed expiration dates

Spread bets have fixed expiration dates determined and set at the time the bet is placed, while CFD contracts do not have fixed expiration dates. Additionally, spread betting transactions occur over the counter (OTC) through a broker, whereas CFD trades can be executed directly within the market. This direct market access in CFD trading provides greater transparency and simplicity, allowing more straightforward electronic trades.

Commissions and fees

As well as margins, CFD trading involves paying commission charges and transaction fees to the provider. Spread betting companies, on the other hand, do not charge fees or commissions. When the contract is closed and profits or losses are realised, you either receive money owed or owe money to the broker.

In CFD trading, if profits are realised, the trader calculates the net profit of the closing position by subtracting the opening position and any applicable fees. In spread betting, profits are determined by multiplying the change in basis points by the dollar amount agreed upon in the initial bet.

Dividend payouts

Both CFD trading and spread bets are subject to dividend payouts if you hold a long position. Despite not owning the underlying asset, the CFD provider and spread betting companies will pay dividends if the underlying asset issues them. When profits are realised from CFD trades, you must pay capital gains tax, while spread betting profits are tax-free.

In summary

Spread betting and CFDs are leveraged investment products with similar fundamentals. Spread betting is commission-free, conducted over-the-counter, and profits are often not subject to capital gains tax. On the other hand, losses in CFD trading can sometimes be tax deductible, and CFDs offer direct market access.

Both strategies involve real risks, and the choice between them depends on the informed decision of the investor. It’s important to note that both CFDs and spread betting are legal only in some countries. CFDs and spread betting are both prohibited in the United States.

Disclaimer:
This information is not considered investment advice or an investment recommendation, but instead a marketing communication. IronFX is not responsible for any data or information provided by third parties referenced or hyperlinked in this communication.