What on earth are CFDs and spread-betting?
You've heard about CFDs and spread-betting so here we'll look at how they work and the difference between the two.
CFDs are Contracts for Difference and, alongside spread betting, are a common way to trade share indices, single stocks, commodities and even FX.
CFDs and spread-betting in many respects work in exactly the same way as we’ve already discussed. There’s a spread, a bid and an offer whilst leverage can be used.
Both are pretty similar. Consider Oil for example where the bid/offer may be as below.
Let’s say we buy at 50.50 for $10 a point. If the market rallies ten points to 50.60 we have made 10*$10 = $100. If it has sold off ten points we’d have lost the same amount.
One neat thing is that both spread betting and CFDs account for a lot of complicated corporate actions with underlying instruments in the background, meaning you do not need to worry about things like stock splits or dividend payments as they are automatically normalised and factored into your account.
This is actually a considerable advantage as the operational burden can be high. However it is worth noting that you do not actually own the underlying stock – only a derivative linked to its price – and therefore you have no voting rights and you effectively have an IOU against your broker rather than owning an underlying security.
How do spread betting and CFDs differ from one another?
Spread-bets are normally a bet with a fixed timescale or expiry whereas CFDs ‘roll’ infinitely like spot FX does. If you are long a CFD you will generally pay a small daily financing charge and if you are short the CFD you will typically be paid a small interest fee. With spread-betting there is no time-related charge or payment.
In the UK Capital Gains Tax applies to gains made from CFD trading but not to spread-betting. Therefore it may be considered more tax efficient to spread-bet.
Spread-betting typically does not incur a commission – the fee is in the broker’s spread. With CFDs it is common (but not always the case) that a fixed commission may be paid on top of the spread.
For more information see here: https://www.financial-ombudsman.org.uk/publications/technical_notes/spread-betting.htm