Contracts Of Difference & Turbos Flashcards
What are CFDs
Stand alone derivative products
Contractual agreement between investor and broker, whereby both parties agree to cash settle the difference between opening and closing price of the contact based on opening and closing prices for underlying asset
Difference multiplied by number of contracts purchased or sold
Based on range of assets (ord shares or indices - FSTE 100)
Trading CFDs based on margin payments
Brokers authorised under FSMA2000
What choices do investors have
Long position (going long)
- believe price of asset is undervalued and will rise in near future
- price rises as anticipated broker credits investors account with profit
Short position (going short)
- believe price of asset will fall
- investor will sell CFD, close out same position by purchasing asset in market for less
Additional considerations to CFDs
Positions monitored daily basis
Contract remains open as long as investor can afford to keep open
CFDs track performance of asset (price movement)
Position or price is owned not asset
Investors must perceive how market will move and try to make profit on that view
No standardisation
Allows investors return and exposure to price movements of asset without owning them (fraction on price)
Investors buy & sell CFDs in products as own rights: net result buying or selling prices of asset which hope they’ll move in their favour
CFD margin payments
Initial margin based on MP of asset x number of units brought/ sold
(10-25% overall contract value)
Depends on broker, price volatility of asset and market volatility
Maintenance margins throughout duration of contact by broker in investors account
If falls below agreed amount subsequent calls made to broker
Short position - amount deducted to account
Long position - investor entitled to sum equal to net dividend payment on shares (div netted against deposit in account)
Prices of CFDs
Brokers quote 2 way price for all CFDs trading (buying and selling)
Prices quoted mirror MP of asset
Varys between brokers (prudent investors check)
Risks of CFDs
Leveraged products (profits and losses magnified)
Suitable for short term investors - longer position greater exposure to risk (price moves against)
Advantages and disadvantages of CFDs
Advantages;
- no stamp duty
- potential profit from falling or rising markets
- stop losses used to limit losses and crystallise gains
- no automatic expiry
- margin not automatic
Disadvantages;
- daily monitoring margin required
- commissions on total position
CFD examples
Long position
= selling spread price x exposure x margin
Commission = selling spread price x exposure x commission
Profit = opening price - closing price = diff x shares
Investors profit - commission = net
(Commission added and financial charges deducted)
Short position
Same working outs
(Commissions deducted and financial charges added)
What are turbos
Similar to traditional CDFs
Leveraged instruments
Traded on margins
Investors gain exposure to price movement of underlying asset / buy or sell turbos not asset
Long - price exposure and hope to sell at higher price
Short - sell exposure at higher price and buy back at lower price
Differences in turbos to CFDs
Lower risks as have embedded stop loss facility (provides degree of protection and means don’t have to monitor daily)
No additional margin calls required throughout life (investor in control of total loss being the initial margin, broker commission and charges)
Turbos should be avoided unless investor is prepared to lose their total initial margin
Advantages or turbos
Lower risk m
Available range of assets
Used by individuals, institutional or corporate investors
Full exposure to underlying asset price movement but for small initial outlay
No additional margin calls
Greater exposure to leverage portfolio than investing in spot market
Long/ short positions so can make profit in falling or rising markets
No stamp duty
Total costs known from outset (all included in initial price)
Purchase dictates opening price to deal at (based on MP) rather than broker
Asset price mirrors turbo
Disadvantages of turbos
No ownership / no rights to asset
Can still lose considerable amount
Once stop loss position reached the position is closed which could result in losses
If price moves adversely so will turbos price (greater in % terms)
