Why hedgers should look at CFDs

Much as we like spread bets, contracts for difference (CFDs) undoubtedly have their uses, and hedging is one of them. Tim Bennett explains.

When it comes to taking a punt on the direction of shares, both spread bets and contracts for difference(CFDs) are possible choices. Both allow you to place up ('long') and down ('short') bets, both are liquid (so opening and closing a position is straightforward), both are margined (so you get lots of bang for your buck) and both are offered by a number of firms so costs are generally low. However, when it comes to hedging, CFDs have one big edge tax.

At first glance, this might seem odd. Surely spread bets are better since they don't attract capital gains tax? Well, for a gambler that's a big plus for sure. Why hand over 18% or 28% of your profits (depending on what rate of tax you pay for income tax purposes) if you don't need to? However, for a hedger someone seeking to protect, say, shares against a price fall the tax treatment of CFDs can be a winner.

The reason is that while, yes, you will be taxed on any gain on a CFD much as though you had bought shares, you also get the benefit of tax losses. What that means is, say you sell a CFD as a hedge against some shares you own and don't want to sell just yet. The shares then rise, rather than fall as you expected. The CFD will lose money you will buy it back to close out the position for more than you sold the contract for. But you'll be able to offset the loss against any gain realised on the sale of shares. So, say you sell shares for a gain of £1,000 but lose £800 on a hedging CFD contract. Your overall gain for CGT purposes is £200, not £1,000 as it would be had you hedged using a spread bet with no tax relief for losses.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

Better still, since CFD prices tend to track the underlying share closer than spread bets, your hedge using CFDs will probably be more precise. So, much as though we like spread bets, CFDs undoubtedly have their uses. Hedging is one of them.

Tim graduated with a history degree from Cambridge University in 1989 and, after a year of travelling, joined the financial services firm Ernst and Young in 1990, qualifying as a chartered accountant in 1994.

He then moved into financial markets training, designing and running a variety of courses at graduate level and beyond for a range of organisations including the Securities and Investment Institute and UBS. He joined MoneyWeek in 2007.