Contract for Difference (CFD)

Definition and Examples of Contracts for Differences

A Contract for Differences (CFD) is a derivative product that refers to an agreement between the buyer and seller to exchange the difference in the price of stocks, bonds, commodities, or other assets between the opening and closing dates of the contract. If the price is higher at the closing date, the buyer makes a profit. If the price was higher at the opening date, the seller makes a profit.

How a Contract for Differences Works

CFDs are traded in units equal to the bid or ask price of the financial instrument used, depending on the transaction. The price at which you sell is the bid price. For example, opening a long CFD position worth $10,000 for the fictitious company ABC would look as follows:

Leveraged Alternatives to Contracts for Differences for Retail Investors

There are other leveraged instruments available in the United States for retail investors, such as options and leveraged ETFs. These instruments are available in the U.S. with leverage ratios ranging from 3.3% to 50%, and are subject to interest rates and fees.

What This Means for Individual Investors

Although CFDs are not available to retail investors in the United States, CFDs and other high-leverage derivatives are used by institutional investors. These large bets can cause significant problems when they go wrong, and smaller investors can become involved. However, the collapse of Archegos Capital in 2021 illustrates how high-leverage derivatives can pose a threat to markets and small investors.

Key Takeaways

Contracts for Differences (CFDs) are high-leverage derivatives typically used by institutional investors. CFDs are not available to retail investors in the United States. Incorrect bets on CFDs can have far-reaching effects in broader markets. Retail investors in the U.S. can utilize other instruments such as options and leveraged ETFs to impact their finances.

Source: https://www.thebalancemoney.com/what-is-a-contract-for-difference-5188634