CFDs
Contracts of difference (CFDs) are a contractual agreement between two parties regarding the settlement of securities. CFDs stipulate that each party will pay for the difference between the opening and closing values of the security. In case the value of the security appreciates throughout the contract time, the seller must pay the buyer for the differences. If, on the other hand, the value depreciates, then the buyer must pay the seller the amount in difference. CFDs have no stipulated contract size or expiry date.
There are two ways to acquire CFDs. The Australian Securities Exchange (ASX) offers CFDs on listed markets. Other exchanges, such as those in Canada, Italy, Switzerland, and the United Kingdom, allow for CFDs on over-the-counter (OTC) markets. Restrictions have been placed on CFDs by the United States Securities and Exchange Commission, thus they are not available in the US. Originating in London in the 1990s, one of the first overseas countries to adopt CFDs was Australia in 2002. Today, CFDs can be traded in a number of exchanges around the world.
CFDs usually include extra charges that are agreed upon. One of the extra charges is a daily financing charge based on a certain interest rate benchmark like the Reserve Bank of Australia. Likewise, commission charges are normally applied to CFDs. Depending on the contract details, the two parties are required to maintain a margin ranging from 1% to 30% of the notional value of the CFDs. This marginal value allows investors to control a larger market position with a smaller budget. There are numerous regulating factors to limit the risk involved in CFDs. Stop orders, stop loss orders, and other strategies are implemented to reduce risks at the cost of increased commission or other means of compensation.
ASX CFDs operate in a regulated market. The Corporations Act requires the ASX to maintain transparency, fairness and order. ASX CFDs make use of a CFD trading system that is similar to other contract transactions. Prices, bids, offers, open positions, volumes and other information on CFDs are always made available to investors. This is unlike OTC markets, which do not keep such close track of CFD trades.
