Hedging using CFDs

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Defensive short positions

CFDs can be used by long-term investors for short-term short-selling opportunities during periods of price correction or short-term pullbacks in the price of shares held within an investment portfolio.

An investor may be holding shares within an investment portfolio with a long-term view that they will continue to rise in price and pay regular dividends. The short-term view may, however, be bearish, or current events may be having a negative impact on share prices of one or more shares within the portfolio. In circumstances like this, the investor may not wish to sell the shares, as the price fall may be only short term.

In times like these, the investor can short sell an equivalent amount of CFDs in the same shares, which allows him or her to take advantage of the short-term downtrend trading opportunity. At the same time the investor continues to hold the shares within the investment portfolio. The paper loss on the value of the shares is offset by the profit from the CFD trade if the CFD trade is closed out for a profit.

This strategy is particularly applicable to the larger stocks, which generally have a propensity to rise in value over the long term, yet can be subject to significant short-term pullbacks within the overall long-term uptrend.

General or market hedge

Long-term holders of a broad-based share investment portfolio comprising a number of different shares can hedge the whole portfolio using index CFDs rather than individual share CFDs. Instead of selling CFDs of each individual share within the portfolio, an alternative can be to sell CFDs in the main market index. Or, if dealing with a Market Maker CFD provider, use can be made of the synthetic sector indices – such as the banking sector index if the portfolio is heavily weighted towards banks.

It is important to note that a Market Maker offering CFDs on indices will normally cover the position by buying or selling in the corresponding futures market. A spread is then added to the bid/ask prices provided, which will increase the overall cost.

A more transparent option may be simply to deal in the appropriate futures contract and hedge the portfolio on a dollar for dollar basis. Many CFD providers also offer the ability to trade futures through futures trading platforms.