CFDs – a better bet?

Contracts for difference are very similar to spread bets in many ways. But when should you use one over the other? Tim Bennett explains.

By Tim Bennett
published

Contracts for difference are very similar to spread bets in many ways. However we'd normally only recommend them for professional traders.

Like a spread bet, a CFD allows you to place 'up' and 'down' bets on a range of assets, from shares to currencies and commodities. An 'up' bet involves buying a contract, hoping the price rises in line with the underlying asset and then closing the bet by selling the same contract for a higher price.

'Down' bets work in reverse, with the opening trade being a sale of a CFD to create a 'short' position. The advantages of using CFDs over, say, betting by trading the underlying asset are similar to those of spread bets it's quicker and usually cheaper to trade a CFD, and you don't get stuck holding the underlying asset.

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Like spread bets, CFDs are margined products you only put down a percentage of the value of the contract up front typically between 5% and 20%, depending on the riskiness of the bet.

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So what's not to like? Well CFDs differ from spread bets in one crucial respect tax. Whilst a spread bet offers tax-free gains, a CFD does not. You pay capital gains tax on profits and can use losses to reduce future CGT bills too. Next, you usually suffer a daily financing charge to run a CFD position. Keep it open for, say, a couple of months and this can add up. So, as a rule of thumb we would only recommend CFDs over spread bets for day traders and institutions such as hedge funds.

Tim Bennett

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.

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