Q:How long does a CFD last for?A: Unlike options and covered warrants cash-based CFDs don’t have an expiry date (futures-based CFD products do indeed have an expiry date that will be specified). As CFDs are traded on ‘margin’ you pay or receive an overnight financing rate linked to the London Inter Bank Offered Rate, (LIBOR). This means that you can keep them running for as long as you choose but in practice CFDs are best used for the stock market if used under around 10 weeks, an estimated point where CFD financing charge exceeds financing charge for stocks. Remember that even if you deposit only a fraction of the market value of the position you will still have to pay interest on the entire value of the position. So, for a £50,000 position where you would put down £5,000, your financing costs would be calculated on £50,000 and not £45,000. So even if you held 100 per cent of the value of your position in cash with the broker you would still be charged interest on the value of that position. It is important to be aware of this when considering your investment objectives as interest charged on long trades can reduce the effectiveness of returns.
It is also interesting to note that IG made an analysis on the average hold period in Australia on Australian shares and found out that traders on average held the stock for approximately three days. When they compared this to the average hold period in Singapore it was more like 25 days. So different countries have different characteristics but in general it’s a short-term trading strategy.
Note: In practice, with current global interest rates at such a low point, it is perfectly feasible to hold positions for up to 6 months.
Q:I was told that CFDs expire every quarter…?A: CFD shares don’t expire every quarter, certain trades do (energies, house prices, basically future trades) but with most markets you can hold a contract for difference for as long as you want to.
CFD should never expire because you are paying an ‘interest’ charge in one way or another. There is no premium like in a futures contract which does expire.
Think of the real world, if you have £5000 in a savings account and you own no shares at all what is the result? You earn interest on your £5000 in the savings account but you have lost the benefit of dividend income from the shares. Going SHORT with a CFD is the equivalent to this. i.e./ you sell shares and put the money into a savings account. Even though no shares are exchanged and money doesn’t go into a savings account a CFD is more or less the equivalent of doing this and mimics (interest rates vary) the result. If you go SHORT with a CFD you earn interest but lose dividend income (it is deducted).
Now, in the real world, if you were to withdraw the £5000 and use it to buy shares what is the result? You lose the income from savings account interest but you gain the income from dividends on the shares. Going LONG with a CFD is the equivalent to this but you pay out interest (which is the same as having lost it) and earn income from dividends (it is deducted).