Investments in financial markets can garner hefty rewards. However, traders simply cannot always access the capital needed to get substantial returns. Leveraged products provide investors the opportunity to get significant market exposure with a small initial deposit.
Popular in the United Kingdom, contract for difference (CFD) and spread betting are leveraged products fundamental to the equity, index markets and Forex. CFDs are basically contracts between financial institutions and investors wherein the latter take a position on the future value of an asset. Similarly, spread betting allows for investors to decide whether the market ought to rise or fall.
Spread betting companies allow purchasing and selling prices to potential investors who position their investments with the purchase price if they believe the market will rise, or sell price when the probability that the market will fall.
Essentially similar in theory, there are still many subtle distinctions that differentiate CFDs and from spread betting.
CFDs and spread bets are considered derivative products which values are primarily derived from an underlying asset. In these trades, the investor has no ownership to speak of in the market. When trading contract for differences, traders are betting on whether the value of an underlying asset is going to rise or fall in the future. CFD providers confer contracts with choice of both short and long positions based on the underlying price of an asset.
A spread is defined as the difference between the purchase price and sell price quoted by the spread betting company. The underlying movement of the asset is measured in terms of basis points with the option to purchase long or short positions.
Spread bets have fixed expiration dates when the bet is placed while CFD contracts have none. Likewise, spread betting is done over the counter through the assistance of a broker while CFD trades can be completed directly within the market.
Investing on Margin
In both spread betting and CFD trading, initial margins are required as a groundwork deposit. Margin generally varies from 0.5 to 20 per cent of the value of the open positions. For more volatile assets, investors can anticipate greater marginal rates and for less risky assets there exist less margins.
Despite the effort of investors, only a minute amount contribute to a percentage of the asset’s value in both spread betting and CFD trading. In both investment strategies, CFD providers or spread betting companies can call investors at a much later date for a second marginal payment.
Apart from margins CFD trading require the investor pay commission charges and transaction fees to their respective providers while spread betting companies do not take fees or commissions.
When the contract is nearing the close and profits or losses are realised, the investor is either owed money or owes money to the company being traded. If profits are later realised, the CFD trader will be able to net a profit of the closing position less than the opening position and fees.
Profits for spread bets will be the adjusted in basis points multiplies by the dollar amount conferred in the initial bet. Both CFDs and spread bets are subject to dividend payments that assumed a long position contract while there is no direct ownership of the asset, a provider and spread betting company will be paying dividends should the underlying market perform well.
Risks in investing can never be averted. It is the investor’s responsibility to make strategic decisions to avoid severe losses. In both spread betting and CFD trading, the possible profits may be as high as 100 % equivalent to the underlying market. However, so can potential losses not be avoided as well.
In both spread bets and CFDs, a stop loss order can be initiated prior to contract initiation. A stop loss is a predetermines price that automatically close the contract once a fix price was stipulated. In order to provide close contracts, some CFD providers and spread betting companies provide guaranteed stop loss orders at a premium price.
With comparable fundamentals on the surface, the tinge in difference between CFDs and spread bets may not be very distinguishable to the new investor. Spread betting, unlike CFDs, is free of commission fees and profits which are not subject to capital gains tax. Furthermore, with both strategies, real risks are very possible and deciding which investment will augment returns is entirely up to the intuition of the investor.