3
$\begingroup$

I'm trying to understand how CFD works. I have question about market maker.

Who is market maker for CFD? Is it a company which provide a trading platform or any stock exchange?

EDIT01 @noob2 thanks for your answer. I have another question: what is the underlying security for indices CFDs?

$\endgroup$
  • 4
    $\begingroup$ CFD is not really a "derivative", although it is presented as such. There are no market makers. It is just an agreement between you as the client and a broker/dealer who can buy sell the underlying security for his own account. So it is just a legal construct to avoid Stamp Duty, not a market security. $\endgroup$ – noob2 Oct 21 '15 at 20:32
  • $\begingroup$ @noob2 this should be posted as an answer. $\endgroup$ – SRKX Oct 22 '15 at 1:48
3
$\begingroup$

CFD is not really a "derivative", although it is presented as such. There are no market makers. It is just an agreement between you as the client and a broker/dealer who can buy sell the underlying security for his own account. So it is just a legal construct to avoid Stamp Duty etc., not a traded security.

| improve this answer | |
$\endgroup$
  • $\begingroup$ What is the underlying security for indices CFDs? $\endgroup$ – torm Oct 22 '15 at 18:44
  • $\begingroup$ Could be an ETF, could be futures,... It depends. $\endgroup$ – noob2 Oct 23 '15 at 19:39
  • $\begingroup$ So, a CDFs broker/dealer decide what the underlying security will be and it is its risk, doesn't it? $\endgroup$ – torm Oct 23 '15 at 19:45
  • $\begingroup$ That's exactly what I think. $\endgroup$ – noob2 Oct 23 '15 at 19:58
  • 2
    $\begingroup$ When there is an underlying and the price of the CFD is derived from that one why wouldn't it be a derivative? $\endgroup$ – vonjd Feb 18 '16 at 13:39
3
$\begingroup$

I wouldn't say it is not a derivative, CFD is for sure a derivative, you don't need any secondary market to be traded with CFDs to make it a derivative. So it is a derivative, only problem is, there are many companies issuing them and if they go bankrupt, you can lose your money. Most companies offer just a few of CFDs though, but some like ETX Capital for example (http://trade-test.com/etx-capital-review) offers around 6000 of CFDs, biggest offer that I am aware of.

An advantage of CFDs is that it can be much cheaper than its base asset as spread is made by the issuing company that can be any broker like that ETX Capita, or Plus500 or Oanda or whatever. And they can sell you CFD with a fraction of spread you would normally pay on a regular market. So conclusion:

  • Risky: yes, somewhat.
  • Cheaper: yes.
  • Do you own asset: no.
  • Do you get dividends: yes.
| improve this answer | |
$\endgroup$
  • $\begingroup$ As you do not own the underlying security you won't get dividend but your account is increased with the same amount of money (or charged if you are in short position). This implies different taxation. $\endgroup$ – Jónás Balázs Mar 30 at 12:45
0
$\begingroup$

Consider the definition of a derivative:

A derivative is a security with a price that is dependent upon or derived from one or more underlying assets.

Or as Wikipedia puts it:

A derivative is a contract that derives its value from the performance of an underlying entity. This underlying entity can be an asset, index, or interest rate, and is often simply called the "underlying".

You may think of CFD (Contract For Difference) as pools of assets. The total price of a pool depends on the individual price of each underlying asset in that pool. This further allows tailoring different groups of assets for all sorts of purposes. The price goes through some "adjustments" too - so simply summation of all the prices does not equal the price of an index.

Example being an index like DAX which has 30 underlying [assets|components|constituents|members] (whichever word you are more comfortable to use). [https://www.boerse-frankfurt.de/indices/dax - click on Contituents tab to see its components] You can use different screening tools for different indexes to see their underlying components.

Keep in mind that the underlying members keep changing from time to time. (Example being a recent new member to DAX, "DAX 50 ESG Index" which was created by Qontigo - Reference: https://www.dax-indices.com/press-releases-details?articleId=1722402906)

Quoting from libertex.com:

Before the digital era, calculating the price of a stock index had to be as simple as possible. The original DJIA was calculated using a simple average: add the prices of the 12 companies and divide that number by 12. These calculations made the index really not more than an average, but it served its purpose.

Today, the DJIA uses a different methodology called weighting based on price, where the components are weighted according to their prices. To calculate the index, the current prices of the 30 shares are added and then divided by what is known as the Divisor Dow, a number that is used to maintain the historical continuity of the index. This number is continuously adjusted to take into account changes in the market, such as equity divisions, spin-off and any changes in the Dow components. In 2008, for example, the value of the Divisor Dow was 0.125553. Today, it is 0.14602128057775.

| improve this answer | |
$\endgroup$

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.