Contracts for difference are all the rage these days, but aside from the normal risks associated with this type of investing, you also need to navigate a playing field lined with fees and charges. Investing in a CFD may appear as simple as paying down the collateral, or what’s commonly known as the margin.
But in fact, that’s only the first expense you will come up against in your CFD investment journey, and if you plan on buying CFDs, make sure to count on additional costs related to spreads and transactions, as well as financing and currency fees.
A CFD’s spread is the difference between the current cost of buying that CFD (the «offer») and the current price at which the CFD can be sold, commonly known as the «bid». The offer used in a spread is higher than the bid. Brokers work with both fixed and variable spreads, and the model you get will depend on which broker you use.
As a rule, spreads are measured in units know as pips. A single pip generally refers to the very last digit on a CFD rate. The spread indicates how high market rates will have to rise before you can make a profit. Whether or not transaction costs are included in the spread depends on the type of CFD in question. Transaction fees are generally included in the spreads of index-based CFDs and commodity CFDs, for example.
But in most cases the spread for exchange-traded fund CFDs and equity-based CFDs only reflect exact market values. Additional costs come into play here, including the per-transaction fee equal to 0.1 percent of each transaction. This fee may, in some cases, be replaced by a fixed fee (10 francs per transaction, for example). A minimum per-transaction fee normally applies. Transaction fees are charged every time you buy (open a position) or sell (close a position).
Finance charges only need to be calculated into the equation when you hold a CFD overnight. This happens when CFD positions are not closed by a preset cut-off time (11:00 pm for example). The finance charges represent a sort of borrowers fee for the leveraged capital. Much like the interest rates charged on a loan, financing charges for CFDs are tallied based on the number of days or nights for which they are held.
The annual base rates (also known as «reference rates») you get will depend, primarily, on the currency in which your CFD transactions are made. In countries which use the euro, the Euro Interbank Offered Rate (Euribor) sets the standard, while British base rates are used in the United Kingdom. Any markup on base rates is decided by individual CFD brokers.
Daily finance charges for CFDs with a long position are generally calculated using the following formula:
Position size x (interest rate markups + annual base rate) x (number of days / 360)
Example: You go long with 5,000 equity CFDs at a closing rate of 10 euros per share, with a position size of 50,000 euros. The Euribor base rate sits at 0.5%, and your broker’s markup on that base rate is 2%. So the finance charges on this «long» CFD, kept overnight, would come to: 50,000 euro x (2% + 0.5%) x 1 day / 365 days = approximately 3.5 euros per day.
When trading CFDs with a short position, on the other hand, the annual base rate is credited to you as the CFD buyer:
Position size x (interest rate markups - annual base rate) x (number of days / 360)
Example: You go short with 5,000 equity CFDs at a closing rate of 10 euros per share, with a position size of 50,000 euros. The Euribor base rate sits at 0.5%, and your broker’s markup on that base rate is 2%. The finance charges for this «short» CFD, kept overnight, would come to: 50,000 euro x (2 - 0.5%) x 1day / 365 days = approximately 2 euros per day.
Day-trades, meaning trades which are opened and closed in the same day rather than kept overnight, do not accumulate finance charges. The absence of finance charges in day-trading is one reason why the majority of CFD trades occur in a short time span, within the same day.
Currency exchange fees are another cost factor to look out for when trading CFDs. As an investor, you can typically select a base currency to be used for your CFD trading account. When you trade CFDs in foreign currencies, every gain or loss those CFDs make will be subject to foreign currency transaction fees. These rates follow a currency exchange spread, the current bid/ask prices for currency trading.