Contracts for difference and binary bets are two highly leveraged but highly contrasting trading instruments, designed essentially for different purposes but often offered by brokers as part of a triple threat of binaries, spread betting and CFDs. Where the two are similar, they have the ability to provide substantial gains for traders backing the right market in the right direction, while their differences are quite considerable in terms of both structure and practical effect.
CFDs: Pros And Cons
Contracts for difference have several major advantages inherent in their makeup that lead traders to consider them a highly flexible and extremely useful trading tool. By far the most significant is the fact that they are margin traded products with a high degree of leverage, allowing traders to become exposed to a range of different markets and indices in much larger positions than they could technically afford themselves. Because margin requirements are often less than 5%, traders can effectively reap the rewards of transactions multiple times larger without fronting the value of the larger transaction themselves, effectively gearing up transactions to deliver increased returns from the same initial capital exposure.
One of the major disadvantages of CFD trading in relation to binary bets is that CFDs are taxable in the UK as capital gains. For higher rate taxpayers, this equates to a rate at present of 28%, whereas even basic rate taxpayers are liable to the tune of 18% of their gains (tax rate might change at any time). This is simply as a result of CFDs being regulated as an investment, rather than a gambling product – a distinction which is in essence largely artificial and unfair to the levels of effort and skill involved in trading binary positions. However, this makes binary betting a more attractive investment option for some trading situations, and puts CFDs on the back foot in at least one camp when it comes to a comparison with binary positions.
Binaries: Pros And Cons
Binaries have a number of distinct features which make them different to CFD trading, including of course their favourable tax treatment. More akin to spread betting as a trading model, binaries settle markets on fixed odds at either 100 or 0, with spreads set at some intermediate point to reflect the likelihood of either outcome. The difference between the spread and either 0 or 100 is the multiple of the stake used to derive profit or loss – a simple transaction with the potential for significant returns of its own.
One of the key advantages of trading with binaries is that even a 1-point movement in your favour results in a heavy win. The position either settles up or down, at 0 or 100 – there are no half measures. A 1-point gain is as good as a 10,000-point gain, effectively allowing traders to win more heavily from fractional market movements.
However, this must be tempered with the consideration that binaries limit earnings considerably to a maximum of 100 less the spread, times your stake, and similarly the risks associated with trading of this sort can be as substantial as the upside rewards for minimal market turns.
Therefore it pays to be familiar with the drawbacks and useful properties of both binaries and CFDs to decide whether one or the other might be more suitable to a given trading situation.