Contracts for Difference (CFD, for its name in English, Contract for difference ), are one of the most popular derivative financial instruments in recent years in Spain. But its late arrival in the country means that many investors still ask themselves certain questions about their nature: What exactly are CFDs about? How do you operate with CFDs?
First, we will begin by defining CFDs as a financial product. By Contract for difference means a type of operation normally performed on stocks or stock indices and in which two players agree to a sort of temporary transfer of ownership of certain assets. Its settlement is made by the difference between the purchase price and the sale price.
An example of how CFDs work
Let us choose a known title, such as the shares of Inditex SA. Let’s say that these are valued at 32.46 euros and we already have, say, 100 of these shares. Well, if we anticipate that there will be a decrease in the price of the company’s shares during the next two weeks, we will create a CFD on them during this period of time. We will deposit, therefore, about 324.6 euros (as a guarantee, which is usually 10%) for its sale less the commissions of the operation.
After three weeks, the period of completion of the CFD is fulfilled and we will recover our 100 shares of Inditex SA or simply close the contract to recover them. However, as we had thought, the price of the titles has fallen by about 5 euros, and now stands at 27.10 euros. Therefore, the benefit is more than clear, about 5 euros on each share, which would be about 500 euros less expenses and commissions.
This would be a simple example of what CFDs are, but it is only an option on how to operate with CFDs of the many possible. Since, also, it would be valid the opposite example in which one tried to open a CFD on a financial asset that does not have to take advantage of a bullish period of the markets or the particular asset.
How to operate with CFDs
Being a leveraged product, CFDs carry much more risk than a stock or foreign exchange investment to use. With leveraged, it is meant that the exposure of the product to the market is much greater than the initial investment made or, in other words, that much more money can be lost than invested. Therefore, knowing this characteristic of how CFDs work is basic. Contracts for difference are an element with a lot of risk and, therefore, should be operated very cautiously.
However, this same feature also works in the other direction: with a very small investment, great benefits can be achieved.
On what elements a CFD can be opened
On a large number of them: from stocks and currencies, to stock indexes, raw materials, options and ETPs. CFDs are a product applicable to numerous instruments in financial markets and have the advantage that they do not need to be owned, so the initial capital required is much lower.