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CFDs Compared to Warrants

CFDs vs Warrants
Written by Andy

Contracts for difference and warrants are both derivatives, meaning that they derive their value from some underlying financial security or stock but are not actually ownership of it. With CFDs, you will never own the underlying, but with warrants you may have the opportunity to buy it. There are several different types of warrants, and each has different properties.

Another attraction of covered warrants is that they trade on the London Stock Exchange, like ordinary shares. So, you can see their price being constantly updated in real time, and deal them whenever the market is open. As opposed to shares, you don’t have to pay any stamp duty, although you may be liable to pay capital gains tax on any profits.

Trading in either financial instrument allows you to gear up the power of your money, taking some sort of financial interest in the underlying that does not cost as much as buying it outright. In that way they are similar, but in many other ways they are different.

Contracts for difference are, as the name suggests, contracts to pay or receive the difference in value of the underlying from the base value when the contract was written until the time the contract is closed. You can profit or lose as much as the value changes, less any fees and charges for the trade.

Covered warrants are a bit more complex to understand than CFDs or futures. If you believe an instrument’s price is going to rise in value, you buy a call warrant and if you believe it is going to fall, you buy a put warrant. In this respect a warrant is like the better known option trade. Warrants are issued by market makers, rather than on a uniform market, so their price can vary. The warrant gives the right but not the obligation to buy or sell the underlying at a certain value on the expiration date or before the expiration date if it is an American style warrant. However, they are usually cash settled, meaning that the difference in value is paid out rather than actually receiving the shares.

One difference between a warrant and options is that there is a market maker selling the warrants, whether it is a call giving the right to buy or a put giving the right to sell the underlying. Therefore you can’t take the other side of a warrant, and receive a premium for selling the call or put in the way that you can with options. Another difference is that the time to expiry can be much longer with warrants than you get with options, sometimes extending to years. However, compared to CFDs, with warrants there’s more to think about than just simply the market’s direction. You also need to consider what price the instrument is likely to reach and whether it is going to get there within a certain period of time.

So how do CFDs and warrants compare? Warrants are simply long dated options issued by a market maker. There is limitations surrounding short selling and the price is very unpredictable. Warrants are similar to CFDs in that they are not transferable between providers. If you bought a Macquarie Bank Warrant, you have to sell it back to Macquarie bank. Otherwise their pricing complexity is similar to that of options.

Both cfds and warrants give you the leverage of derivatives, multiplying the effectiveness of your money. Both can be used to profit from an increase in value of the underlying, or can be chosen to profit from a short position, when the underlying falls in value. The main difference is that a warrant will cost a premium, which will be lost if the trade goes against you. One advantage of covered warrants is that they are exchange traded (in much the same way as ordinary shares). This means that you check their prices in real-time and deal them whenever the underlying market is open. Unlike shares, warrant deals are not subject to stamp duty, although you may have to pay capital gains tax on any profits.

On the other hand, a CFD can cost you money if the trade goes against you, but you can select whether to liquidate your position and exit the trade at any time so you can limit your losses. If the trade goes in your favour, you will profit immediately, and not have to make up the amount of the premium before you see any return. Having said there with CFDs there is always a possibility that you could end up losing a lot more than your initial investment if the commodity you’re trading moves strongly against you in a short-time period. This is not so with covered warrants where the maximum loss is limited to the amount you originally paid at the outset. One attraction of trading warrants in this respect is that despite the limited downside they still allow you to make magnified gains from small price moves and it is quite feasible to turn, say a 10% move in a commodity into a 100 per cent gain – or loss. It is worth noting here that cover warrants are leveraged by varying degrees, usually betwen 4 and 10 times, meaning that profits and losses are multiplied by those amounts.

As far as market coverage goes CFDs win hands-down here. For instance, most warrant issuers will only offer only the more popular commodities crude, copper and gold while CFD providers will cover the full range of commodities and will typically cover less traded instruments like uranium and the agricultural commodities. As both financial instruments are for active traders who want to be engaged in their investments, on balance the CFD should provide you with increased returns.

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