One of the big differences between financial spread betting and contracts for difference is that contracts for difference have margin calls. For many investors this will be the first time they have come across them, so it’s good to know what they are.
First let’s look at another difference between Contracts for Difference and spread bets, and that’s to do with timing. Spread bets run out. If your bet is still out of the money when your deadline has run out then you simply clear up and go home. You’ve lost your money. The same goes for a traded option.
Contracts for Difference don’t expire. Essentially they can go on for ever. However the contract may go on for ever but if the contract is underwater for a long period of time then can it still be said to be alive? At some point or other it is going to need to be prodded with a stick. These sticks are known as margin calls.
A margin call has a minimum margin, which is the amount that the investor puts into the trade. This may be, for example, 10% of the pay-out that they would be expected to make. If the expected pay-out increases over time, then it will follow that the minimum margin will grow. As the margin needs to be maintained then the investor will have to find the money. If they can’t then the position is liquidated.
The margin call is a price that is paid for the flexibility of the CFD instrument. Essentially it is the difference between losing all the money at the end of the bet, and having the option to roll it over at less (but still real) cost.