In Which George Explains Contracts for Difference

shutterstock_London-square-mile

My colleague George recently returned from North Korea, where he oversees Sand Hill Exchange market operations.

George is an active CFD (contract for difference) trader, a thing I have long been curious about. I asked him to explain CFDs to me. Here is how the conversation went.

George, what is a Contract for Difference?

A contract for difference (CFD) is a derivative that allows investors to speculate on the movement of the price of a stock without owning the asset.

Wait a minute, what’s a derivative? I thought a derivative was just a bet.

Here George spends the next four hours explaining derivatives to me using ponies and jellybeans.

Oh, I get it now. A derivative is a contract that specifies payment conditions based on an independent thing. Like a bet, but enforceable in court.

Yes. For an equity-based CFD, it’s an agreement that the seller will pay the buyer the difference between the current value of a stock and its value when the contract was made. If the difference turns out to be negative, the buyer pays the seller.

CFDs generally have no expiry date and track the prices of their underlying asset.

Why don’t I just buy the stock instead of doing this CFD thing?

With CFDs, you don’t have to pay the full price of the stock. You can trade on margin. With my IG account, I can leverage my money 10x when trading equity CFDs.

Plus, I can trade on all sorts of things in one place. I don’t need to wait until markets are open, which is hard because I spend a lot of time in North Korea. I can also trade on things where public markets don’t even exist, such as pre-IPO companies.

CFDs sound awesome. How do I get started?

CFDs are pretty awesome, but you should be aware of the risks. The CFD provider serves as the counterparty for all the bets you make. As the “house”, they will charge a spread which could trim your profits.

Also the CFD industry is not very regulated. Be careful that your CFD broker isn’t some fly-by-night bucket shop.

To get started, move to some country that is not the United States.

What the hell man?

Yeah sorry. Under the Dodd-Frank Act, CFDs are considered security-based swaps. Transactions in security-based swaps must be done on a registered national securities exchange and offers and sales to retail investors must be registered under the Securities Act of 1933.

This is probably an important lesson for you to learn.

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s