CFD and Stock Options

Apart from trading directly in equities, traders have the option of participating in another way as well; they can trade in derivatives instead. Option trading is one of the popular derivatives and has been quite popular with experienced traders. While options have been there since long, many beginners are not familiar with CFD, a derivative product that is relatively new to the Australian markets.

A CFD or contract for difference provides an option to traders to trade in stocks or any other financial instrument in the market without ownership. For example, you can trade a Telstra CFD without having to buy its shares.

Contract for difference is an agreement for paying or receiving the difference between the closing price of the underlying asset and the price at the time the contract was entered into. Every CFD has an underlying asset. It could be a share, commodity, currency pair or an index.

Many investors often ask how it is different from trading options. The primary difference and also the reason why it is preferred over option trading is the simplicity of its pricing. The primary feature of option trading is the time premium attached to it. The premium decays as it nears the expiry date. A contract for difference reflects only the price of the underlying stock; there is no time value attached and no premium to decay. Moreover, CFDs are available for a wide range of underlying assets.

However, the element of risk is the same as in stock and forex trading. Since it employs a high level of leverage, the risk of losing money is as great as the increased potential for profit should the markets move adversely. It is thus recommended that investors be careful while trading in CFDs.