Innovative Products
The Growth of Contracts for Difference (CFDs)
Contracts for Difference, or CFDs, are instruments linked to the performance of the price of an underlying financial instrument, such as shares, indices, market sectors, treasury securities, metals and commodities. CMC offers CFDs only on financial instruments. Unlike conventional financial instruments, such as shares, CFDs do not confer ownership of the underlying instrument. Rather, a CFD is an agreement between two parties to exchange the difference in value between the opening and closing value of the contract, generally determined on the basis of the price at which the underlying instrument is traded at the time of opening and closing the contract, respectively. In the United Kingdom, the Group's CFD offering includes financial spread betting and foreign exchange trading.
Trading in CFDs is one of the fastest growing forms of financial trading worldwide. The success and growing popularity of CFDs is due to some of the features that CFDs offer, which are not easily available to retail investors trading the underlying financial instruments through traditional brokers.
The popularity of CFDs can be attributed to the three main principal advantages:
Leverage
Leverage allows clients to invest only a small percentage of a position's value whilst still maintaining full market exposure. The ability to leverage an investment allows investors to:
- reduce the initial capital outlay required to deliver a market exposure similar to that obtained by investing directly in the underlying financial instrument;
- pursue risk diversification strategies, by using the "excess" capital to invest in other CFDs and obtain market exposure to a wide variety of underlying financial instruments irrespective of the location of the underlying exchange; and
- magnify potential investment returns.
Flexibility
As well as going long to benefit from rising markets, traders can take short positions and potentially profit from falling markets. Traditionally, a retail investor did not have the opportunity to take a short position or could not do so without incurring significant transaction costs. As there is no transfer of the underlying financial instrument, the investor in a CFD is able to take a short position without the need to involve a financial intermediary and can therefore do so at an all-in deal value lower than that required to go long.
In addition, CFDs also allow investors to trade fractional units of the underlying financial instrument.
Transparency
Clients can easily compare prices with those in the physical market, as they are derived from the underlying cash market. This transparency makes understanding the pricing of a trade as simple as it would be for a physical instrument.
