Contract for Difference (CFD)
A Contract for Difference (CFD) is a financial instrument that allows two parties, a buyer and a seller, to agree to exchange the difference in the price of an underlying asset at the time the contract is made and the price of the asset when the contract is closed. CFDs are commonly used for trading stocks, commodities, currencies, and indices.
For example, let’s say you want to buy a CFD for 100 shares of a company’s stock at a price of $50 per share. The seller agrees to sell the CFD to you, and if the price of the stock increases to $60 per share, the seller will pay you $1000, which is the difference between the current price and the agreed-upon price of $50 per share. On the other hand, if the stock price decreases to $40 per share, you will have to pay the seller $1000.
The life cycle events of a CFD involve the opening of the contract, the monitoring of the underlying asset’s price, and the closing of the contract. The contract can be closed at any time, and the profits or losses are calculated based on the difference in price between the opening and closing of the contract.
There are several types of CFDs, including equity CFDs, commodity CFDs, and forex CFDs. Equity CFDs involve trading shares of a company, commodity CFDs involve trading commodities such as gold and oil, and forex CFDs involve trading currency pairs.
Payments during the life cycle of a CFD depend on the settlement method, which can be either cash settlement or physical settlement. Cash settlement involves the payment of the difference in price between the opening and closing of the contract, while physical settlement involves the delivery of the underlying asset.
Swift messages are not specific to CFDs but are used for general communication between banks and financial institutions. However, Swift messages can be used for confirming CFD trades and settlements between parties involved in the transaction.
Valuation of CFDs is typically done based on the current market price of the underlying asset. The broker or trading platform used to execute the CFD trade will calculate the value of the contract based on the current market price of the underlying asset. The profit or loss is calculated based on the difference between the opening and closing prices of the contract.
During the lifespan of a CFD, the following events can occur:
- Contract initiation: The buyer and seller agree on the terms of the CFD, including the underlying asset, contract size, and duration.
- Opening of the contract: The buyer pays the initial margin to the seller to open the contract.
- Monitoring of the underlying asset: The parties monitor the price of the underlying asset, which determines the profit or loss of the contract.
- Adjustments: In some cases, adjustments may be necessary, such as for corporate actions like stock splits, dividends, or mergers.
- Closing of the contract: The contract can be closed at any time by either party, resulting in a profit or loss based on the difference between the opening and closing prices.
- Settlement: Depending on the settlement method chosen, the parties may exchange cash or physical delivery of the underlying asset.
- Termination: The contract may reach its expiration date, resulting in automatic termination.
Throughout the lifespan of the CFD, the parties involved may also communicate through various channels, including email, phone, or electronic trading platforms.