## Q.: What are the costs of trading CFDs?

Example: Suppose we take the example of a £100,000 trade in Sainsbury's Plc expecting the security to rise to 415p in the next four weeks.

The current bid-offer spread is Sainsbury's Plc 388.4 - 388.6.

Using an online CFD trading provider you would pay a commission of 0.1 per cent when opening the position and another 0.1 per cent when closing it. Also, for a long position you will be charged interest if you decide to hold a position overnight. This is referred to as a financing charge and is typically based on LIBOR plus 2.5 per cent. This small overnight fee comes to play because for overnight positions the product is considered as an investment where the provider has lent you the money to buy it and is one way a CFD provider makes money from deals.

Buy 25,733 contracts at 388.6p = £100,000.

You deposit £10,000 as margin.

Sainsbury rises from 388.4p to 420p in 25 days.

Profit = £106,792 - £100,000 = £8,079.

Less opening commission of £100.

Less interest charges of £20.55 x 25 days = £513.75*.

Less closing commission of £100.

Overall net profit = £7,365.25.

Return on capital employed is £7,365.25/£10,000 = 73.65 per cent.

* Assume that this equates to a financing rate of (5% + 2.50%) = 7.5%, and the closing price for the day is 388.6p. You will pay 25,733 x 388.6p x 7.5%/365 = £20.55 for holding the position overnight. This will be debited from your account on the next trading day. Note also that with today's low interest charges the financing rate would more likely be just 3% which makes it much more advantageous to trade using CFDs as you can hold positions for longer without being charged a lot.

## Q.: Do I get charged commission for buys and sells?

A: Yes. The opening and closing trades constitute two separate trades, and therefore you are charged commission for each trade.

The costs of CFD trading involve the commission charged by the broker (usually 0.1%), a financing cost if you buy assets and the spread, i.e. the difference between the bid and offer prices at the time you trade. There is usually no commission charge for trading forex pairs or commodities and in this case, the spread represents the cost of the CFD. There also may be a funding cost or interest received as well. Long positions entail financing costs, while short positions earn interest.

For an example of the costs of trading CFDs, suppose a trader wants to buy CFDs related to the share price of GlaxoSmithKline. The trader wants to place a £10,000 trade, with an expectation of the share price increasing to £24.80 per share. The current price is £23.50. The bid offer spread is 23.48-23.50.

You would pay 0.1% commission on opening the position and another 0.1% when the position is closed. Also, for a long position you will be charged overnight, normally the LIBOR interest rate plus 2.5%. This is known as the financing charge, as the overnight positions for the product are considered an investment and the provider has lent the trader money to buy the asset.

The trader can buy 426 contracts at £23.48 per share, which amounts to a trading position of £10,002.48. If margin requirement is 10%, then you would deposit £1,000.25. Suppose the share price of GlaxoSmithKline increases to £24.80 in 16 days. The initial value of the trade is £10,002.48 but the final value is £10,564.80. The increase in the GlaxoSmithKline share price is shown in the graph below, indicated by the upward sloping arrow.

The profit before charges and commission is 10,564.80 – 10,002.48 = £562.32.

Then on opening the position, you have to pay 0.1% commission, which equals to £10.

Since it is a long position, interest charges are made on each of the 16 days. Suppose the interest charged is 7.5%.

Then the daily interest charge is:
426 times £23.48 times 0.075/365 = £2.06.

Then since the position is open for 16 days, the total interest charge is:
16 times £2.06 = £32.89.

Then once the position is closed, another 0.1% is taken as commission, which is equal to £10.

Therefore the overall net profit is equal to profits minus charges, which is
526.32 – 10 – 32.89 – 10 = £473.43.

The return on capital employed is £473.43/£1,000.25 = 47.33%.

If buying shares rather than CFDs for this particular trade, the costs would be slightly different. Say we purchase 426 shares at £23.48, this would require an initial capital outlay of £10,002.50 plus a stamp duty charge of 0.5%. This costs £5.00 for this trade plus the £10 charge. If you then sold at £24.80, then you would have £10,564.80. You would have made a higher amount, £547.30, but you had to risk all of your capital. Per £1,000, the share trade profit was £46.73, while for the CFD trade £1,000 was risked to make £473.43. Generally, CFD trading is more profitable over the short-term than shares trading, as the overnight financing costs will start to eat at profits over the longer term, i.e. 90 days or more.

## Q.: How does the provider make money?

A: Say, your capital is \$10k, with CFD margin 10%, so you can 'shop' for \$100k worth of share. Assume you want to buy XZY Ltd share at \$20 a share, hence you can buy 5000 shares of XYZ Ltd. Also let say you, hold the position for 90 days.

For long position (expecting upturn):
You will need to pay the margin interest: interest rate + 'hair cut'
Say the "hair cut" is 3%, then you need to pay 6.5% + 3%=9.5% for 90 days:
Interest: 9.5% x \$100000 (not \$90k, because you have to pay interest on the full position) x 90/365 = \$2342
(Quick money with solid collateral, they hold the share which is very liquid and if anything
happens to the price you are the one who pays it - so for the CFD provider this is a kind investment that is quite safe with a nice return on investment)

For short position (expecting downturn):
You will be given: interest rate - 'hair cut'
Say you hold short position for 90 days, you will be given:
(9.5% - 3%) x \$100000 x 90 /365 = \$1602
(CFD provider has \$100000 cash from the proceeds and they keep them as long as your position hold - "free money" that they can make use to work for them!)

The CFD provider will pass on the dividend given by the company (usually on ex date not on pay date - at least my provider does that - so faster dividend money than if you hold ordinary share), but you will not have the franked credit - they will enjoy the franked credit. Be careful when you hold short position and it is dividend time, you will be the one who pays the dividend to the owner of the stock that you "borrow".

## Q.: My provider charges me 15 basis points each way. But what are basis points and how are they calculated?

A: 15 basis points is 0.15% which is about just right for a contract for difference (although there are some providers like Ayondo who charge 0.10%). If your provider reduced your commission from 0.15% to 0.10% it would amount to a change of 5 basis points. i.e. a basis point is 1/100th of 1%.

## Q.: Please provide me with a quick example comparison of buying a share versus cfds in terms of costs?

A: Let's take DGO as a comparison (and IG Markets as the broker).

Share purchase say 5000 shares at £3.40 that's £17000 @ .5% stamp duty £85 plus £10 cost.

CFD 5000 shares at £3.40 that's £0 plus .3% Guaranteed Stop Loss £51 plus £10 cost. (sorry, you must have the margin in your account so if my stop was at £2.00 then £7000 would need to be deposited).

I pay around 3% interest pa also to InterTrader. This would equate to £1.40 per day for holding the 5000 shares with them.

To summarize cfd dealing beats share dealing if dealing 180 days or less. But if share hit £2.00 then cfd will be taken out auto (not that my stop is there) shares you are liable to market makers...etc

## Q.: Do CFD brokers really allow people to trade index CFDs commission free?

However, one other thing that you need to consider are overnight financing charges. CFD providers usually charge a financing rate for holding positions overnight which may be as high as the LIBOR rate plus or minus 3% (sometimes more). This means that if you hold a CFD trade for a year you would be charged [3% + LIBOR%] per annum calculated as a daily rate. It is important to note that this financing charge is charged on the whole position size (not just the amount you have borrowed). I find this slightly unfair as the broker wouldn't be considering the money you have deposited with them and charge you on the full position amount. The only provider I know that charges financing only on the amount you have borrowed is Ayondo.

## Q.: Do you know of a CFD broker that does not charge commission on UK Shares CFDs?

A: If there are any, the commission will be hidden in a widened bid/ask spread which will cost you the same or more as a commission. If a CFD broker says they don't charge a commission they are not saying the truth as they run a business and thus are there to make a profit, they just hide their commissions into spreads (buy/sell difference is higher).

When trading CFDs, the very visible costs in trading are the interest payments and, the commission (brokerage). Sometimes the brokerage is zero. Looks good so far.

However the spead can be a costs that many new CFD traders are not familiar with.

You see, the spread is the difference between the bid and the ask prices. You buy at the ask, which is the higher price (or offer as it's also known) and sell at the bid, which is the lower price. This is one way that a broker of any trading instrument makes their money.

Typically the 2 prices in the spread aren't very far apart and in reality the bid-offer spreads are very competitive these days. However, there may be times where the spread widens quite a bit and hence if you're trying to sell, you'll actually sell at a lower price than you may expect due to the widening of the spread and hence make not as high a profit as you could have.

Depending on the CFD provider, the spread may be widest first thing in the mornign for the first 5-15 minutes. So trading at this time may cause erratic results.

How do you get around it?

You could:

1. Trade after this morning havoc is over. So watch the market and see when the spread narrows again.

The risk of this is that if the price of the stock CFD is falling and you're trying to sell, the market movement may negate any benefits you get by waiting for the spread to settle.

2. Use a DMA CFD account where you can get the actual opening price (participate in the opening auction), if you wish to exit the price at the opening price for whatever reason, eg you design and trade a system where you get out at the open.

The advantage of this is that you can place the trade the night before (with many CFD providers you can) and not have to hang around the screen for half an hour or more in the morning wondering when to press the sell button, and will save you time and energy.

So there you have it. These are the basic ways you can get around the spread going crazy in the mornings with some CFD providers.