Tuesday, October 5, 2010

Contracts for Difference (CFDs) Vs Futures

Contracts for Difference and Futures are both forms of financial derivatives. A financial derivative is an instrument whose value is derived from the underlying asset. In the case of CFDs and futures, the underlying asset may be a stock, bond, commodity or more. But the most common underlying asset for both CFDs and Futures is shares. There are three core differences between futures and CFDs. Liquidity, expiry dates and financing.

Liquidity is a standard issue for basically all futures exchanges except for the giant that is OneChicargo - the largest futures exchange in the world. Futures markets have become famous for slipped trade executions (slippage) and bad execution. This is because of the lack of volume associated with the trades. As futures are exchange traded products there is sometimes no counter party to execute the trade at the appropriate level, causing sporadic movements in the price of the future.

CFDs however have almost infinite liquidity because they are (mostly) not an exchange traded product. You are guaranteed to complete your opening order at the price you requested and that was displayed by your broker. While there is some slipped trade executions, this is usually due to synthetic price determination, not lack of liquidity.

Expiry Dates are another big difference CFDs have to futures. Expiry dates exist on futures because in the traditional sense, this is the date that the asset has to be delivered and the agreed price. Since most futures contracts are closed out before the expiry date occurs, the asset doesn't physically get delivered but technically there is still one in place. This supports the financial markets and allows people who actually want to own the share (or other asset) the ability to obtain it.

Finally, financing is another differentiator between futures and CFDs. They are both leveraged products where there is a borrowing element involved in the purchase and interest is either paid or earned but CFDs are more like purchasing a share with a loan from the bank while futures have their leveraged components priced into the asset.

Vincent Parker is the author of 123CFD a resource on Contracts for Difference (CFD) Trading

This article was Contracts for Difference (CFDs) vs Futures

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