Futures contracts and contracts for difference (CFDs)

Contracts for difference (CFDs) and futures contracts are two types of derivative financial instruments that allow investors and traders to speculate on the prices of financial assets. However, there are some differences between these two types of contracts.

Futures contracts

Futures contracts are derivative contracts, which means they are derived from an asset, such as stocks, commodities, or foreign currencies. Futures contracts are traded on regulated markets, such as the Chicago Mercantile Exchange (CME) or the New York Mercantile Exchange (NYMEX).

Futures contracts are agreements to purchase or sell a specific asset with a fixed price on a specific date later to the Agreement. If the asset price increased on the maturity date, the buyer will gain a profit, and if the price decreased, the buyer will endure loss.

When you buy a futures contract, you agree to buy the asset with a fixed price on a future date. This price is known as the delivery price.

On the maturity date, the buyer must purchase the asset from the seller with the agreed delivery price. If the price of the asset decreased on the maturity date, the buyer will gain a profit. If the price decreased, the buyer will endure loss.

For example, if the buyer purchases a futures contract for 100 barrels of oil with a delivery price of $100 per barrel, and the market price of oil on the maturity date is $110 per barrel, the buyer will gain a profit of $10 per barrel, with a total amount of $1,000. Conversely, if the market price of oil on the maturity date is $90 per barrel, the buyer will endure a loss of $10 per barrel, with a total amount of $1,000.

Contracts for difference (CFDs)

Contracts for difference (CFDs) are financial derivative instruments which allow traders to speculate on the prices of financial assets without actually owning them. CFDs are traded through financial intermediaries, and usually their price is linked to the asset’s price.

Contracts for difference (CFDs) are contracts between two parties, known as the buyer and the seller. The buyer agrees to pay the difference between the asset ‘s price at the time of contracting and the price at the contract’s expiry date. If the asset ‘s price increased, the buyer will gain a profit with the difference amount. If the price decreased, the buyer will endure loss with difference amount.

For example, if the price of a company’s share is $100, and a trader buys a CFD contract on the later share, the trader will gain a profit of $10 for every point rises in the share’s price. If the share price increased to $110, the trader will gain a profit of $100 (10 dollars x 10 points). If the share price decreased to $90, the trader will endure loss with a total amount of $100 (10 dollars x 10 points).

Futures contract and CFDs trading

To trade in future contracts or CFDs, you must first open a trading account with a financial broker. Once your account is open, you can start trading.

When trading in future contracts, you must decide whether you want to buy or sell the contract. If you thought that the price of the asset will increase, then buy a contract. If you thought that the price will decrease, then sell the contract.

When trading in CFDs, you must decide whether you want to buy or sell the asset. If you thought that the price of the asset will increase, then buy a CFD. If you thought that the price will decrease, then sell the CFD.

You can also determine the leverage ratio you want to use. The more leverage you use, the greater risks you may be exposed to.

When closing your trade, you can either sell the futures contract – CFD, or buy it back. If you sell the contract, you will gain profit if the price of the asset decreased. If you buy the contract back, you will gain profit if the price of the asset increased.

Futures contracts can be on a variety of financial assets such as (stocks, bonds, forex, commodities, indices). CFDs can be on a variety of financial assets such as (foreign currencies – stocks – bonds – commodities – indices).

Investors can buy CFDs on companies share or future contract on share indices. Traders can buy CFDs on foreign currencies or futures on commodities.

Futures contracts advantages

• Hedging against risk: Futures contracts can be used to hedge against the risks associated with other assets. For example, an investor who owns shares in a company can buy a futures contract on those shares. If the price of the share’s decreased, the investor will endure financial loss, but he will be able to offset their losses by gaining a profit from the futures contract.
• Speculation: Futures contracts can be used to speculate on the prices of financial assets. For example, an investor who believes that the price of a company’s share will increase can buy a futures contract. If the price of the stock increased, the investor will gain a profit.
• Access to new markets: Futures contracts give investors access to new markets, such as commodity markets or global markets.

CFDs advantages

• Ease of access: CFDs can be traded through online financial brokers, making them accessible to traders of all levels.
• Leverage: CFDs allow traders to use leverage, which means they can trade with a greater value than they have in cash.
• Hedging: CFDs can be used to hedge against the risks associated with other assets, such as shares or bonds.

Futures contracts and CFDs risk

1- Futures contract delivery risks: the buyer shall buy the asset from the seller with the delivery price on the maturity date. If the price of the asset increased – more than expected – on the maturity date, the seller will endure loss more than expected.

2- Profit and cost risk: Profits and losses from the CFDs can be very high, as they are calculated based on the difference between the opening price and the closing price.

3- Leverage risk: Investors can use leverage in futures contracts or CFDs, but it can amplify losses expeditiously, which could lead to a total loss of capital.

4- Fluctuation risks: Contract prices can be extremely fluctuated, which means that profits and losses can be quite significant.

Differences between Futures contracts and CFDs

1- Delivery: In CFDs, the asset is not delivered, but profits and losses will be calculated based on the difference between the opening price and the closing price. On the other side, in futures contract the asset is delivered on the maturity date.

2- Leverage: CFDs allow investors to use leverage, which means they can open positions that are much larger than they can afford in cash. On the other side, most Stock markets do not allow investors to use leverage in futures contracts.

3- Cost: CFDs trading costs are lower than futures trading costs.

4- Risks: CFDs are associated with greater risks than futures contracts, because investors do not bear delivery risks.

How to choose between Futures contracts and CFDs?

• Investments goals: If you want to speculate on the prices of financial assets without being delivered, then CFDs will be the best choice, and if you want to buy and hold financial assets, then futures contract will be the better choice.
• Skills and experience: CFDs are more complex than futures contracts.

CFDs and futures Contracts can be very profitable, but they are also risk, prior trading in CFDs, it is important to understand the risks and put an effective trading strategy, Start small, don’t put all your money into trading, start with a small amount until you feel comfortable with the risks.

Prior trading you shall learn its fundamentals, in terms of how markets are analyzed and risk management. Use risk management tools, there are many risk management tools available, such as limit orders and stop loss, so use these tools to protect your capital. Be prepared for the possibility of losing money.