Trade CFDs or Options

There are similarities between trading CFDs and trading options. The first is they both provide leverage to the trader. Also, you don't need a large account to start with either. They both, in different ways, allow you to control a greater value of financial securities than you could if you had to buy them outright, and so they give you leverage of your money. They also have the advantage that it is as easy to make money from falling values as it is from rising prices.

However, CFDs and options diverge at this point. With options you pay a premium, either for a call or a put depending on your view of the market, and if the price swings in your direction, you can make a good profit. If the price stays the same, and assuming you didn't pay extra for an option that was already in the money, the option expires worthless and you lose your premium. If the price goes in the wrong direction, you again lose your premium, but your losses are limited to this.

Option prices are derived from different components, many more than a CFD. The most important being the price of the underlying share (as with CFDs), but also by volatility, time to expiry, prevalent interest rate and supply and demand factors. The number and complexity of price indicators that options can demonstrate creates a lack of transparency in their pricing. The formula for correctly pricing options was awarded with a Nobel Prize! No easy feat, adding credibility to the complexity of the instrument. With this noted, it is easy to see that the price of an option can significantly vary to that of its underlying asset.

CFDs are easier to understand. Their value is directly related to the underlying shares, and you profit or lose in direct relation to their price movement. As such CFDs have a much closer relationship with the price of their underlying asset. This means that analysis and valuation of your CFD portfolio can be done through examining the market of its underlying asset (eg stock). Information on listed shares is more widely available and analysis is plentiful and thorough. With contracts for difference, your initial margin would be 5% to 10% of the underlying value, so this is where you achieve the high leverage that you need to make a good profit.

If the price swings in your direction, you make as much as a shareholder would make, less some minimal interest charges. If the price stays the same, then you are down by the amount of interest. If the price goes in the wrong direction, you could be down as much as the shares declined, but you would be guilty of foolishly ignoring the slide normally one of the first things you should do when you open a trade is set a stoploss so that your position is liquidated with only modest losses if the trade is wrong.

One of the key differences is in understanding what you are trading. The CFD is transparent, with anyone who understands the stock market (or other market) able to comprehend what the trade is and the expected outcome. Options have a reputation for being rather more difficult, and a true student of options needs to know about the 'Greeks' in order to determine how the price may vary, and create the best profit opportunities.

While that can be learned, the other major problem with using options is the time factor. A contract for difference can be held as long as needed, even though there will be some interest charged for holding a long position. Options have built-in expiration dates, and if the expected move in the price of the underlying does not occur before expiration, an otherwise good trade may still result in the option expiring worthless because of timing. It is no problem for the CFD trader to hold on for another week or two until the move happens, and to benefit fully from their insight.

Simply put, the complexity of options pricing means they are priced as their own instrument and trading them means learning many new indicators. Since CFDs mimic the stock they are following, there is little information beyond standard stock market analysis that is required to trade them.

 ...Continues here - Covered Warrants and Turbos

Recommend this on Google