CFD Trading vs Futures Contracts Explained

CFDs and futures contracts are two popular types of derivatives. Although they have many common traits, these are two different financial products. This is the reason why many traders get confused and can’t decide which of them to include in their investment portfolio. 

This article will explore the difference between futures and CFD trading, their main features, advantages and disadvantages so that you could choose the most suitable form of investing and achieve success in the financial market.

The article covers the following subjects:

What Are The Futures Contract and How to Trade It?

A futures contract is a deal between two or more parties to purchase (long position) or sell (short position) a particular asset at a predetermined price and at a set time in the future. While the buyer undertakes to purchase the underlying asset when the contract expires, the seller is obliged to provide the buyer with the agreed asset at the specified date.

Futures contracts are usually present in various markets such as:

There are two main types of investors in the futures contract market:

  1. Speculators. They take the risk and try to benefit from favorable price fluctuations. These traders purchase when expecting the asset price to grow and sell when anticipating the drawdown. Speculators have a crucial role in the market – they foster financial market liquidity.

  2. Hedgers. They own or are willing to purchase the inventory of a commodity. Thus, in contrast to speculators, they use futures to protect themselves from price movements. They purchase or sell to establish a favorable price for the assets they want to buy or sell later in the cash market.

A futures contract is one of the most liquid financial instruments that allows buying/selling an asset  in the future at the price predetermined today.

Futures are primarily used to hedge against the risk of loss and secondary – for speculating. 

After each closed trading session, the exchange publishes reports, analyzing which, you can check the actions of the exchange itself. Forward means that the contract will be executed at a predetermined future settlement date and price. As you see, futures trading is is suitable and beneficial for all market participants.  

Features of the futures

Each underlying asset has different conditions for futures trading, though there is some similarity in the same group of trading instruments (currencies, different types of oil, stock indexes and so on).

Each futures contract has the following characteristics:

  • name;

  • expiration date;

  • minimum price fluctuation; 

  • the amount of the underlying asset in the contract;

  • minimum price fluctuation; 

  • point value;

  • margin requirements;

  • product code (ticker);

  • contracts listings (quarterly, monthly);

  • settlement;

  • trading hours.

As the transaction involves two sides, you can take part as a buyer or seller, but any exchange contract always involves two sides.

Example of a Futures Trade

Here is an example of futures contract trade in the crude oil market. Let’s say it’s May and the contract expiration date is in July. The oil price is $60 per barrel. If the speculator expects the price to go up until July, he can buy the contract at $60. In case he wants to take control over 1000 barrels it doesn’t mean that he needs to pay $60000. He will only have to provide the margin of 5% (in futures trading it’s usually kept at 5% or 10%), thus, $3000. If the futures contract is closed in July with the oil price of $65 per barrel, the investor wins $65000-$60000=$5000. In case his expectations were not correct and the oil price goes down to $55, he will carry the loss of $5000.

Futures Pros 

  1. Transparency. Since futures are traded in the official markets they are highly standardized. This makes futures trading more transparent in terms of regulations and pricing.

  2. Liquidity. The majority of the futures markets are highly liquid, which allows investors to enter and exit the market the time they want.

  3. Risk management. Futures allow individual investors and companies to implement hedging strategies to protect themselves against potential risks.

Futures Cons

  1. Timing issues. Futures imply a predetermined expiration date, which means that as it is approaching the price for the asset can decrease and become less favorable to others.

  2. Leverage. It is both a merit and a drawback of futures trading. It can be the reason for increased profits and magnified losses.

  3. Entry barrier. Since futures are traded on big exchanges their minimum contract size is large and rather rigid, which makes it more challenging for small investors to enter the trade.

  4. Regulations. A vast number of different regulations make the process of opening an account in the futures market much more complicated.

Types of Futures Contracts

There are many different types of futures contracts in both financial and commodity markets. Here are the most widespread of them with examples:

Financial Futures

Financial futures trading usually refers to speculating on  interest rates, stocks, and currencies. Financial futures contracts are the most liquid financial instruments that allow buying/selling an asset  in the future at the price predetermined today. 

Forex Futures

These are exchange-traded currency derivatives. They operate close to regular futures contracts, meaning that the contract parties are obliged to sell and buy the asset at an agreed price and predetermined date. However, fx futures are not traded on a centralized exchange, instead, they are available on various exchanges worldwide.

Interest Rate Futures

These futures contracts imply that the buyer and the seller agree on the future delivery of any interest-bearing asset. When trading interest rate futures, investors can either speculate on the changes in the interest rate or use hedging strategies against them. However, it’s important to remember that the interest rate futures price changes inversely to the interest rate itself.

Single Stock Futures

Single Stock Futures or SSFs suggest that a seller and a buyer exchange a particular number of stocks at a previously agreed price. Since the buyer expects to profit from the stock price increase, he is considered as a long party, while the seller who benefits from the price decrease is called a short party. The first SSF trade took place in the US in 2002. Nowadays, single stock futures are available in a wide range of financial markets worldwide, including India, Spain, etc. 

Index Futures

Index futures imply that the parties, involved in the deal, agree on the future delivery of an underlying index. Index futures are usually based on equities such as S&P 500 index, NASDAQ 100, AEX, and others. This type of futures contract can be used by both speculators to profit from index price fluctuations and by portfolio managers to hedge their equity positions against potential losses in stocks.

Commodity Futures

Commodity futures usually refers to price speculating on oil, natural gas, gold, silver, wheat, corn and more.

Grains Futures

Grain futures are contracts between two or more parties defining the delivery of the grains at an agreed price and predetermined date in the future. These contracts have standardized quality, quantity, time, and place of delivery. The only changing parameter is the price. The most widely used grains commodities include wheat, corn, oats, rice, etc.

Metal Futures

Metal futures are the agreements between parties on the delivery of the metal at a specified price and date. Such contracts let investors avoid holding the physical metal but use leverage to enter the market. Most popular metal futures markets include:

  • gold features;

  • silver features;

  • cooper features, etc.

However, it’s crucial to remember that despite offering significant profits and hedging against inflation, trading in the metal futures market comes with great substantial risk as well.

Energy Futures

Energy futures have energy products as an underlying asset. The most common energy products include crude oil, natural gas, and electricity. This type of futures contract is available on formal exchanges or in over-the-counter (OTC) markets. In contrast to other types of commodity futures, it doesn’t have a long history. Energy futures were first traded in the 1970s as a tool to control market volatility.

Softs Futures

These futures are one of the oldest to be traded. They are based on agricultural products that are grown, such as sugar, coffee, cotton, etc. Softs futures are usually used either by farmers that act as hedgers or investors that speculate on the product price moves. Softs futures are more volatile in contrast to energy or metal futures since it’s complicated to predict weather conditions and other risks related to farming. 

Livestock Futures

Livestock futures are standardized agreements where the underlying asset is livestock. The only market in the US that trades livestock futures is the Chicago Mercantile Exchange (CME) located in Chicago, Illinois. These futures contracts were first introduced in the 1960s and underwent some changes to allow livestock producers to better manage their risks.

Futures trading and margin requirements

To discuss the margin requirements for the futures, we first need to understand what is the margin in general and what types of margin can be in the forward contracts market.

Initial margin 

This is the equity required to initiate a futures position.  This is not a credit or a loan, it is neither the payment for an asset. Unlike margin loan, it doesn’t suggest borrowing money at an interest rate. Margin is the amount of money you should have on your account before you open a position. It guarantees the exchange that you are solvent and financially reliable. 

If you do not have enough funds on your account for the initial margin you can’t initiate a trade for a futures contract.

For example, you have $4000 on your trading account, You want to buy a euro futures contract at the exchange rate of 1.1160. The Initial Margin is now 2200$ per contract. Accordingly, when you open a long position with one contract, $2200 is blocked on your account. Next, if you continue holding your long positions, the profit is added to this amount if the price is growing, or, if the price is falling, the amount of loss is deduced, depending on the market conditions. 

Differently put, the initial margin is a particular amount of money that you should have on the day of the position opening (first clearing), multiplied by the number of open contracts. In our example, the remaining free margin is 4000 – 2200 = 1800.

Maintenance margin

If the holding time of your position goes beyond the second trading session, then you have to comply with the Maintenance Margin. It is the amount of money that you must have in your account in order to maintain a futures position running, like an overnight margin. It is usually less than the initial margin by some percentage points. 

Let us go back to the example with the EUR futures trade. For example, we decided to hold on the trade through the third trading session, Since the transfer date, there is applied maintenance margin that is $2000 as of now,

We entered a purchase at 1.1160. In some time, the price fell by 50 points. At the moment of the second clearing transfer, the price for the futures is at level 1.1110. Therefore, we have a loss of 50 * 12.5 (point value) = $625. Our deposit is 4000 – 625 = 3375

Point value is the amount of currency by which the trader’s deposit changes if the price rises or falls by one point. The actual value can be found in the specification of contracts on the official website of the exchange/broker. 

On the next day, the price again goes down this time from the level of 1.1110 to level 1.0990. The loss is 120 points (or 120 * 12.5 = $1500). After the clearing, our deposit is $1875. This is already less than the maintenance margin, so, what’s next? Shall we expect a Futures Margin Call from the exchange????

Fut. Margin Call is the message from the broker asking you to deposit more money into your account so that your margin balance (account balance) is at the maintenance margin level again in three days. Otherwise, futures positions that do not meet the conditions will be forcibly closed.

If you receive a margin call, you can:

  1. Increase the amount of capital in the account, release funds from other positions;

  2. Close a part or all of your futures position

  3. Just do nothing, thinking that everything will be settled down by itself if you pray to the god of the market.

Intraday margin and intrasession margin 

This type of margin is specified by the broker only for futures day trading, traders will not transfer their positions through clearing. It is usually much less than the maintenance margin, being about 10% of it. Although different firms may provide different terms and conditions. 

The intraday margin is valid throughout the entire trading session until the last minute. Operating with such a type of margin, the trader agrees to independently close positions before clearing, otherwise, the transactions will be forcibly closed by the broker as the deposit doesn’t match to the size of the maintenance margin.

In general, this type of margin is used by traders who do not trade big amounts of money. They fail to roll their positions over to the next day, they can’t also make profits from the gaps. So, they must carefully consider whether such trading is worth of stock. 

When is the margin returned to the account?

  1. When an offsetting transaction is executed

  2. When a position is forcibly closed by the broker/exchange, minus the amount of uncovered losses from the free funds of the trader.

An offsetting transaction is a transaction opposite to the original position. For the buyer, the offsetting is a sale. For the seller, it is a purchase. When a transaction is offset, no margin will be charged.

What Is A CFD And How To Trade It?

CFD or Contract For Difference trading is a type of derivative that lets speculators profit from the price fluctuations of the underlying asset between the opening and closing trades. CFDs provide investors with a wide range of financial products such as stocks, commodities, forex, indices, etc. Moreover, they can be traded on more than 15000 global markets.

Here are some of the most important CFD features to be aware of.

  1. Investors never own the underlying asset, they gain profit due to the changes in the asset price value.

  2. CFDs don’t have a fixed expiration date.

  3. CFD trading, the same as futures trading, comes with an opportunity to use leverage.

  4. CFDs are considered OTC products and are not available for trading in the US.

Example of a CFD Trade

CFD traders benefit from the price difference. They buy the asset if the market is expected to grow (going long) and sell it if the market is predicted to fall (going short). 

If the investor wants to buy 1000 stocks (for $50 per share) of a company that he expects to do well in the market he doesn’t need to pay $50000. It’s necessary to provide only the initial margin, in our example, let’s take 5%, thus $50000*5%=$2500. 

  • In case his expectations are correct and the share price increases to $55, his profit will be ($55-$50)*1000=$5000.

  • In case the asset price goes down, despite prediction, and the investor closes the trade with $48 per share, his loss will be ($50-$48)*1000=$2000. 

Yet, it’s crucial to remember that the loss may exceed the initial investment. It’s all about the leverage. On the one hand, it allows investors to significantly increase the profits, but, on the other hand, it comes with the risk that they can lose more than their initial investment. This is because both profits and losses are calculated by using the total size of the position.

CFD Trading: Pros

  1. Flexibility. CFDs provide investors with great flexibility. They come with smaller contract sizes and cover a wide range of financial products (indices, commodities, crypto, forex, etc.)

  2. Easy entry. One CFD usually equals one share. It means that it’s easy to open a trading account without huge money investments.

  3. No expiration date. CFD trading allows investors to exit the trade when the value of the asset goes in the opposite from the expected direction.

  4. Liquidity. Since traded directly by brokers, who often act as market makers, CFDs are considered to be highly liquid.

CFD Trading: Cons

  1. Geography. Being an OTC product, CFDs are not allowed in some countries, including the US.

  2. No centralized exchange. CFDs are not usually traded on official exchanges. Thus, since they are provided by brokers, there are no standardized regulations, which can be very confusing.

  3. Leverage. As in the case with futures, CFD leverage can help investors or become a reason for tremendous losses.

Comparison Between Trading CFD vs Futures Contracts

Parameter

Futures contract

CFD

Regulation

More regulated

Less regulated

Leverage

Yes, up to 1:15

Yes, up to 1:1000

Contract size

Large

Small

Flexibility

Less flexible

More flexible

Expiration date

Yes

No

Spread

Yes

Yes

Liquidity

Liquid

Very liquid

Markets

Central exchanges

More than 15 000 markets worldwide

Going short and going long

Yes

Yes

Summing Up

CFDs and Futures are similar types of derivatives, however, they have their particular features, merits and drawbacks. CFDs are more flexible, they don’t have an expiration date. Moreover, they offer a high level of liquidity and a great variety of financial products. Futures, in contrast, are better regulated, can be found on official exchanges, however, come with more complicated conditions to open an account.

Understanding the differences between CFD vs futures contracts will help you choose the most suitable trading instrument and let you build a robust investment portfolio.

The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteFinance. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.

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