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Contract for Difference (CFD) – Summary

  • A contract for difference is a contract between two parties, buyer and seller, stipulating that the seller will pay to the buyer the difference between the current value of an underlying equity share and its value at contract time.
  • However, if the difference is negative, then the buyer pays to the seller such difference. A CFD is an equity derivative contract that allows the inves-tor to speculate on share price movements, without the need to own the underlying shares.
  • A contract for difference offers all the benefits of share trading without having to physically own tshares. A CFD is ideal for short-term technical trading and hedging positions in the underlying market.
  • An investor can sell a CFD as an opening position, since a CFD is a contract between the investor and the CFD provider, based upon the price movement of the share.
  • An investor may be able to profit from a falling market using this instrument of CFD.
  • The investor having a long position is required to pay a daily financing charge applied at an agreed interest rate above or below LIBOR or some other interest rate benchmark, while an investor holding a short position receives such interest.
  • Clear margin is the investor margin account adjusted for all positions marked-to-market, less initial margin requirements for all open positions.
  • Interest is normally paid to the investor on such clear margin at a preagreed rate of interest.
  • Investors in CFDs are required to maintain a certain amount of margin as defined by the counter party or market maker, which could range from 10 to 30 percent.
  • The amount required to be held in the margin account will be as per the terms and conditions imposed by the market maker or counterparty.
  • CFDs offer several advantages, like transparent pricing, effective use of capital, increased trading flexibility, access to international markets, stamp duty exemption in some markets, receipt of dividends on bought open positions, receipt of interest on sold open positions, the ability to go short, high leverage, and so on.
  • However, CFDs suffer from increased trading risk due to the high leverage that it inherently offers to the investors. CFDs are not suitable for long-term investment and there are no voting rights for a person who is long in CFDs, unlike an investor holding traditional shares.
  • CFDs do not have an expiry date. They remain open until they are closed in accordance with the terms of the client agreement.
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