WHAT IS A CFD?

A Contract for Difference, or ‘CFD’, is one of the most popular over-the-counter derivative financial products in Australia and also globally, due to their relative simplicity to trade, low cost, and the ability they give to profit from both rising and falling markets.

A ‘Contract for Difference’, is a contract between two parties to exchange the difference in the price of an underlying asset from the time the CFD contract is opened and the time the CFD contract is closed. CFDs are a leveraged product and require a trader to deposit a fraction of the total value of the position (known as margin) to open a position.
CFDs are derivatives because their value is derived from the value of another asset (e.g. a share traded on ASX or an international stock or a futures contract traded on a futures exchange).

When you trade in CFDs, you take a view on the potential change in the price or value of the underlying asset. You are speculating on whether the value of an underlying asset is going to rise or fall in the future compared to what it was when the CFD contract was executed (opened).

Initial Margin – The initial deposit needed to open the CFD contract.

Variation Margin – As the price and value of the open CFD contract changes throughout a day as the underlying asset price and value changes so does the variation margin requirement. The variation margin is the value of the unrealised loss on an open CFD contract (debit variation margin) or the unrealised profit on an open CFD contract (credit variation margin) and is expressed as a percentage of the full notional value of the open CFD contract. The CFD trader must maintain the total of the initial and debit variation margin real-time as the open CFDs position value increases and/or decreases.

Margin Calculation – For example, you wish to buy 100 ABC CFDs at $35.00 and the ABC CFD has a margin of 5%:

 

CFD Margin Volume Price Notional Value Initial Margin (5% of Notional Value
ABC

5%

100

$35

$3,500

$175

Day 1

Balance of Trading Account i.e. Equity Initial Margin  Variation Margin Free Equity

$5,000

$175  $0

$4,825

Day 2

The market price of ABC trading on ASX falls to $34 and thus, the price of the ABC CFD also falls to $34.

Balance of Trading Account i.e. Equity Initial Margin Variation Margin Free Equity

$5,000

$175  $100

$4,725

Day 3

The market price of ABC trading on ASX continues to fall to $33 and thus, the price of the ABC CFD also falls to $33.

 

Balance of Trading Account i.e. Equity Initial Margin Variation Margin Free Equity

Before Close CFD

$5,000 $175  $200

$4,625

After Close CFD

$4,800 0 0

$4,800

 

The loss (or profit) of the CFD trade is the difference between the total notional value of the CFD contract at the time of opening the CFD contract compared to the total notional value of the CFD contract at the time of closing the CFD contract. So in the above example this is a loss of $200 being ($3,500 less $3,300).

CFDs allow you to gain exposure to the underlying asset traded on a market, with a lower capital outlay (margin). The underlying asset can range from equities, Indices, futures and commodities, across Australian and global exchanges. FP Markets also offer Margin FX contracts .