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Revealed: The ins and outs of CFDs

by , 05 August 2013

If you fancy adding a bit of trading excitement to your portfolio, how about CFDs? By trading CFDs you can profit when the market is rising and falling. Read on to find out more about how they work…

CFDs, or contracts for difference, are a great way to capitalise on the moves of a share or other underlying asset, explains Viv Govender, analyst of Index Trader.

A CFD is an over the counter (OTC) derivative since you don’t trade it through an exchange (like shares), but through a bank or company who provide CFD trading.

When you trade a CFD, you agree to exchange the difference between the open and close price of the contract with the market maker (the bank or CFD trading company).

The four key properties of a CFD
  1. A CFD’s value derives from (depends on) the value of an underlying asset. For instance, the Woolies share price.
  2. A CFD isn’t standardised. This means it isn’t traded through a regulated exchange (like the JSE), but through a bank or a company providing CFD trading.
  3. CFDs have no expiry date. Other derivatives, for example, single stock futures, do.
  4. CFDs involve daily financing charges. If you hold a long CFD position, then you pay daily financing; if you hold a short CFD position then you receive daily financing

How the funding works for CFDs

If you’re long a position, you have to pay a daily financing charge.

If you’re short a position, you receive a daily financing charge.

Generally the market maker will charge 2% on top of the SAFEY rate. The SAFEY rate is the South African Futures Exchange Yield, or interest rate.

This is an annual percentage so the daily rate has to be calculated. You also have to maintain the margin.

Let look at the difference in funding with a couple of examples…

A long CFD position

Let’s say you decide to go long the SatrixFini. This is an ETF that tracks the top 20 financial shares on the JSE.

So you buy 100 STXFIN CFDs at a price of R8.

Since this basket of shares consists of the top 20 financial shares on the market, you get the same exposure to the market would cost you hundreds of thousands of rand.

But since you’re trading CFDs you’ll only need to put down a margin.

With this long position you’ll need to pay financing on a daily basis. This funding charge made up of the SAFEY rate and the daily closing value of the shares.

Long example:
SAFEY is 5.22%
The market maker adds 2%
The closing share price is R8.30
So the daily funding cost is:
100 x R8.30 x (7.22%/365) = 16.42c.

The bank or CFD trading company deduct this amount from your trust account by the next trading day.

A short CFD position

Let’s say you expect STXFIN to head down.

Because you’re shorting this time, you receive the daily financing position.

As before this is based on SAFEY, but you deduct the market makers fee from the SAFEY rate.

Short example:
SAFEY is 5.22% minus the market makers fee of 2% = 3.22%.

So the daily funding cost is:
100 x R8.30 x (3.22%/365) = 7.32c.

Just like the above example, the funding charge is calculated and credited to your trust account the next day. This calculation happens every day, including Saturdays and Sundays, as long as you’re in the position.

So there you have it, what CFDs are and how CFDs work.

Revealed: The ins and outs of CFDs
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