Trading CFDs Vs Futures

As we discussed in our article “What are CFDs and how do they work ? “ CFDs were first developed as part of the evolution of Financial Futures markets. But in the decades that have followed their creation, the protege could be said to have eclipsed its creator. In this article we will look at what makes CFD trading such a popular alternative to trading Futures.

OTC

One of the main drivers of the growth in CFDs was the fact that they could be traded OTC or Over The Counter. As opposed to being traded via an exchange, as is the case in traditional Futures trading. Whilst that is much less of a distinction in today’s all electronic markets. At the outset of CFDs this was a big deal. Because it meant that CFD prices could be created and disseminated by the contract provider in real time. Rather than relaying an essentially delayed or indicative price from the trading pits on various exchanges, as was the case in Futures trading at the time.

Direct Market Access

Because CFDs could be traded OTC in real time, at prices generated by the CFD provider. They were the perfect candidate for electronic trading and DMA or Direct Market Access. A process through which clients trade directly with the market via trading software, without any intermediation, unless specifically requested.

The internet and specialist trading software connected CFD traders from their homes and offices and ultimately anywhere they found a reliable internet signal. Futures markets would eventually evolve into electronic exchanges and mouse clicks replaced face to face,open outcry trading. But the Futures exchanges were and still remain, largely focused on their traditional institutional, wholesale and professional customers. And not on the needs and requirements of the retail investor. A niche that brokerages such as Blackwell Global sprang up to fill.

Standardised, Not Flexible

Futures exchanges were by and large created to service the needs of Producers and large scale Consumers of commodities and agricultural products. Both of these groups wanted certainty around the price, the quantity and quality of the commodity traded. As well as the timing and location of its ultimate delivery. Standardised contracts, that were traded on a monthly or quarterly basis, which controlled a known amount, of a specified quality of the underlying. That had to be delivered by a fixed date, at a specific location, met these requirements perfectly. And though the advent of Financial Futures in the early 1970s moved trading away from the Producer and Consumer relationships of the past. It did not change the Futures exchanges focus on the wholesale end of the market. Contract sizes remained broadly fixed and were usually far too big for most private individuals to even consider trading.

Long or Short

Because CFDs were and are Contacts For Differences and are therefore settled in cash and not the delivery of the underlying instrument, which the contact is over. Users do not need to have delivery arrangements in place. Nor do they need to have access to a supply of the underlying in order to sell a contract on that instrument.

In Futures markets, particularly in Commodities and Metals, traders need to be able to demonstrate they can take or make delivery of say Crude Oil or Gold, at the locations specified by the exchange or clearing house. True these services and facilities are usually provided by Futures brokers or their clearing agent. But they are provided at a cost and are subject to the rules and policies of the relevant exchange and clearing house. CFD traders do not need to consider these matters for one second as the contracts they trade are non deliverable. Instead they can focus solely on their trading and money management strategy and getting that right.

Simpler Pricing

As there is no delivery in CFD trading, just settlement in cash between buyer and seller. It also follows that there is no real need for multiple prices for each instrument, that clients need to keep an eye on, unlike Futures trading.

For example a leading US Futures exchange is currently offering 14 or more separate delivery months and associated prices on its US Crude Oil contract. This is just the kind of thing major Oil Producers and Consumers, who need to hedge their exposure want to see. But for retail traders and others that are purely interested in near term price movements, this information is likely to be a distraction and just so much market noise.

Blackwell Global offers it clients a single rolling spot price on its US Crude Oil CFD contract.This means you have just one price and one chart to watch in US Crude Oil. Though in truth you will likely want to keep an eye on the price of UK Crude Oil and the US Dollar as well, as and when you are trading Crude Oil CFDs.

Because CFDs are open ended contracts, without any fixed expiry date. Their pricing is also often more straightforward, than that of monthly or quarterly Futures contracts. Futures contract prices are calculated inclusive of the cost of carry to their expiry date. Put another way they are priced to reflect the cost of borrowing the funds necessary to hold the assets that make up underlying contract, until the day on which it expires.

So for example the cost of holding a Futures contract for one month, will usually be less than that for holding it for three or six months into the future. This is one of the reasons that creates a differential in the price of far month contracts, over nearer delivery months, within Futures trading. In CFD Trading the financing or cost of carry is calculated and charged on rolling basis. But only if you hold those positions overnight. Intra day traders do not pay financing charges on their CFD Trading.

Smaller Deal Sizes

At the beginning of this article we noted that CFDs are today mostly traded OTC or Over The Counter and that their prices are calculated and distributed by the CFD provider. In effect it’s their price rather than an exchange’s price. The ownership of that price means that the CFD provider can also set the parameters of trading in that contract. One of these parameters is the minimum deal size. We also noted earlier that Futures exchanges and their contracts evolved to serve the needs of the wholesale markets and institutional customers, which they largely still do.

For example the lot size (or standard minimum deal size) for one of the world’s most popular US Crude Oil Futures contracts is for 1000 barrels of Oil. Whilst Blackwell Global’s US and UK Oil CFDs have a minimum size of a 1 /10th of standard lot or just 100 barrels of Oil. This is just another example of the flexibility that CFD trading offers when compared to Futures trading.

Availability of Leverage

Both CFDs and Futures are leveraged products. That is to say that traders place a deposit or initial margin on each trade and post variation margin as required, to meet any running losses during the lifetime of a trade. But this is another area where CFDs offer more flexibility than their exchange traded peers. The leverage or margin level for a given Futures contract / delivery month and is set by the relevant exchange and or clearing house. This margin rate will apply to all participants.

The phrase margin refers to the deposit per lot that a trader must lodge to open and hold a position.
Such that a margin requirement of say 20% implies a leverage ratio of 5 : 1. That is 5 * 20 = 100.

Margin requirements per lot on the leading US Crude Oil Futures contracts are, at the time of writing circa $2800.00 per lot. which is equivalent to an approximate leverage ratio of 17:1.

In CFD Trading the margin or leverage levels and their application are set by the CFD provider.
At Blackwell Global we set our margin levels based on the client’s account size rather than the individual products they are trading. Blackwell Global offers margin ratios of up to 400: 1. *

*For further details about leverage & account operation please see Account Overview.

What’s more if a client decides they would like to trade with us using a different level of leverage to that which is allocated to them, they can request to do so. Remember though that leverage, wherever it’s applied is a powerful trading tool. But is one that cuts both ways. It can magnify trading profits but it magnifies trading losses just as well. Please ensure that you fully understand the risks involved before you engage in any form of margin trading.

To see the benefits that CFDs offer to traders for yourself why not register for a free Demo Trading Account with which you can experience highly realistic simulated trading without risking any of your capital.

When you are ready you can apply for a Live Trading Account make a deposit and trade the markets for real.