Types of CFDs: CFD Markets
The following examples are ways in which CFDs can be used in your trading, and some of the most recent financial instruments invented. Some people find they need little else for their trading career, given the versatility and range of choices offered.
What markets do CFDs cover?
Contracts for differences can be traded on a vast range of different financial instruments, depending on the access that your CFD broker has to various underlying market price feeds and the range of markets available to trade is constantly expanding. The main CFD market types include:
- Global stock CFDs, examples. United Kingdom, USA, Asian and European.
- Stock index CFDs, examples. FTSE, Dow, NASDAQ, NIKKEI, etc.
- Forex CFDs
- Industry sector CFDs, examples. oil and gas, banks, technology, etc.
- Commodity CFDs like soft commodities and grains.
- Metals and energy CFDs, e.g. gold, silver, oil, natural gas, uranium..etc.
Whenever you hear the term commodity, you probably think of the futures market. Trading commodities using CFDs has some advantages for a speculator. Many commodity CFDs have the futures market as the underlying, rather than the commodity itself. This means that there is an expiration date associated with the underlying which your broker will deal with in one of two ways — either he will automatically roll it into the next month contract, or he will cash settle the existing contract and offer to open one on the next month for you.
Unlike futures, with a CFD you have no possibility that you will receive physical delivery, because it will always be cash settled. You do not need so much money, as the margin percentage is usually lower with CFDs, and also because you do not have to take the standard lot size of the futures contract. You’re not usually charged commission, and the broker will profit from the spread between the bid and ask prices.
Given the recent interest in gold following the financial turmoil, the gold CFD gives a trader a direct play on the metal, rather than investing in mining and exploration. Depending on your broker, you may find you can choose a CFD on the spot price of gold, or can trade on the gold futures price. The standard size of contract may be 10 ounces or 100 ounces, and margin could be as little as 3% of the value.
The only way in which this is not as good as holding physical gold is that you are charged interest daily, so you need to time your move into gold CFDs to coincide with an uptrend. However, you don’t get stuck with any storage or security issues.
A trader’s favorite, the volatility of the oil markets gives plenty of opportunity for the active trader to profit. Prices vary not only with obvious supply and demand caused by perceived shortages or oversupply, but are also seasonal.
You will find crude oil CFDs available on the New York market (NYMEX) and on Brent crude which is traded on the Intercontinental Exchange (ICE). Usually the CFDs are based on 100 barrels, and the margin rate for commodities is commonly 3%.
As an example, suppose you wanted to take a bullish position on US crude, and you were quoted $78.25-$78.50. If you bought five crude oil CFDs with a margin rate of 3%, this would work out to $1177.50 (taking the higher price of $78.50), and with this margin you would control $39,250 of oil. Later that same day, oil was quoted at $80.75-$81.00, and you decided to close your position. You would close at $80.75, for a total value of $40,375. Your profit on the trade is $1125.
It’s true that most people think of oil when they consider trading in the energy sector, but natural gas CFDs are less volatile and more predictable. Your CFD broker should be able to write gas CFDs on both the UK and US markets. Gas CFDs are usually traded with the futures market as the underlying, unlike oil.
As noted above, using CFDs to trade on the futures market needs that you are not restricted to the large lot sizes demanded on futures, and you will usually get a better margin rate. These two facts make CFD trading on natural gas much more accessible than taking out a futures contract.
CFDs allow you to profit wherever you find a growth area, regardless of where in the world it may be. As it is as easy to go short as long, you can also profit from a declining economic sector.
With sector CFDs you take an overall view of the economy, choosing for example healthcare as a solid growth industry. They save you having to analyze the individual companies, and you only need to see the big economic picture to select profitable areas to trade. With sector CFDs, you automatically have diversification, which reduces volatility compared with single stocks.
The only point to watch with sector CFDs is that they tend to have a bigger spread than do CFDs on individual stocks. If you’re considering a sector that is dominated by one or two large companies, it may well work out cheaper to trade CFDs on the individual companies rather than taking up the sector CFD.
UK traders now have the opportunity to profit from trading on inflation, as given by the monthly Consumer Price Index (CPI). This is offered by only one broker at present, GFT Global Markets UK Ltd., who also offer an inflation CFD on the European rate of inflation given by the Eurozone Harmonized Indices of Consumer Prices (HICP). As there is only one broker making the market for these, liquidity can be low.
The spread on these is about 0.1, and margin requirement 5%. You have a choice of going long or short on them. The CFDs are paid out on the basis of the initial published CPI figures, ignoring any subsequent revisions. If you’re concerned about rapidly increasing inflation devaluing your portfolio, you can use these CFDs as a hedge to avoid big losses.
Carbon Trading CFDs
Another very recent idea, and one that is both volatile and political, is a contract for difference with an underlier of the futures contract on emissions values. The carbon pollution program allows users to emit a certain amount of the gas, for which they get a permit. If they subsequently improve their performance (reducing the emissions) then they can sell their excess to others who need it.
The price of carbon emissions has varied from 8 to 30 Euros per ton in the last couple of years, with a typical value of about 13 Euros at the end of 2009. Incidentally, a VP at Shell recently estimated the actual cost to eliminate one ton of carbon dioxide is more like 72 Euros.
So with that as a background, Saxo Bank has launched a CFD product based on emissions futures. They require a minimum trade of 25 tonnes, and a 10% margin, which makes it a very reasonable trade, if somewhat hard to predict.