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I’m looking for research specifically for CFD brokers wanting to hedge risk when a customer buys CFDs.

Preferably research on using derivatives like options, futures etc to hedge the risk, instead of just simply buying the underlying with another market participant.

I.e. a customer buys a CFD that is long AAPL, so CFD broker buys AAPL calls or sells puts to hedge the risk, NOT just replicating a % of client’s order with another market participant.

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CFDs (Cash for differences) is a delta 1 product. This is a way for an investor to get synthetically long (short) the asset by buying (selling) the CFD. They participate in the appreciation (depreciation) of the asset without having to own it. The investor is able get long (short) the asset without putting it on their balance sheet. In effect, they are borrowing to get exposure to the asset. As a leveraged position, the investor will pay financing to the broker to put the position on their balance sheet. The interest can be fixed or floating (SOFR + spd).

If a dealer is paying a customer the appreciation on the underlying, they will have to hedge themselves by sourcing the risk, as they are short the asset. In other words, get long exposure to the asset to hedge their short position via the CFD they sold to the customer. They are in effect putting the asset on their balance sheet, and will receive interest from financing the position on behalf of the client. To source the risk, they will have to purchase the asset at the strike of the CFD. Alternatively, they can get long exposure to the asset synthetically themselves (ie. buy CFD aka Total Return Swap, future, fwd, revcon (long call and short put at the same strike)).

At the interim payment exchange dates, they would pay the client the appreciation or receive depreciation; and receive the interest payment. At the maturity or final payment exchange date, they would pay the client the appreciation or receive depreciation since the previous payment exchange date, receive the interest payment, and unwind their long position in the underlying.

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  • $\begingroup$ Where is the profitability in the revcon play for the CFD broker? The difference between the interest paid by the investor and the implied volatility risk premium? Otherwise I am unsure how the profitability works out... I am mainly trying to understand different "synthetic" exposure techniques, and was hoping if there was already pre-existing literature on it, or similar. $\endgroup$
    – Xerium
    Feb 7 at 2:08
  • $\begingroup$ @Xerium This is a rather lengthy topic for the comment section. I answered another question of revcon with respect to borrow here: quant.stackexchange.com/questions/77949/… Also, you can research put-call parity and that should provide some clarity. $\endgroup$
    – AlRacoon
    Feb 7 at 2:58
  • $\begingroup$ Just going from your previous post so I understand. If an investor longs a CFD of AAPL at 100, then the broker can buy a call and sell a put with both K=100. Then if the price jumps to 120, the broker exercises their call and profits the difference the investor makes (minus the price of the call), but also profits from the shorted put that was never exercised and the commission (loan). If AAPL goes down to 80, then the broker profits from the commission and the investor’s “loss” but has losses on the long call and the shorted put loss is the same as investor’s loss (minus put price). $\endgroup$
    – Xerium
    Feb 7 at 13:18

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