CFDs Versus Options

CFD Trading versus Options Trading. Which is best?

Today we’ll take a closer look at Contracts for Difference or CFD Trading versus Options trading and identify the key advantages and disadvantages of both.

When looking to trade Contracts for Difference (CFDs), put options, call options or futures contracts, it’s important to understand they are all ‘derivative’ products which means their price ‘derives’ from something else. In the case of CFDs, options and futures derivatives, all of their prices derive from the stock, index or commodity that they are tracking.

Which is the best product to trade?

I am commonly asked which derivative is the best. Is a CFD better than an option or a futures contract? There is no simple answer to this question because the derivatives are all different. Some strategies that can be implemented with options or futures cannot be implemented with CFDs, but despite this CFDs are a fantastic instrument to trade. 

What are my options when trading Options?

An option is the right to buy or sell a set number of shares (usually 100 in the US and 1000 in Australia) on or before a set date.  Note that with options you have the right to buy or sell meaning you are under no obligation to do this. When trading in CFDs both the buyer and seller have an obligation to settle the difference in cash at the end of the transaction. The CFD trader can choose the size of their position down to as little as 1 contract.

Why are CFDs much easier to understand than Options?

For options, you pay out a small premium, which gives you access to the movement in the share for a set time. If you are right, you receive a large amount of cash back. If you are wrong, you forfeit the small premium.  CFDs are a much less complicated derivative than options.  Trading CFDs is just like trading the underlying share. CFDs have no expiry date, no time decay and no complex pricing methodology. 

In the options market, you can choose to write options. Because of this it is possible to combine options to create different strategies that cannot be created with CFDs. There is no equivalent to writing options with CFDs.

Your Investment Selection is Huge with CFD Trading Versus Option Trading

CFDs provide a wide choice of instruments to trade. It is possible to trade more than 500 Australian shares, international shares from the United States, Europe and Asia. In addition to this, you can trade indices around the world, commodities, currencies and even sectors. No other derivative available today allows this much choice. In Australia, options are limited to just 80 shares.

Two types of options can be traded, either a call option or a put option. Buy a call option if you believe that the share is going up and buy a put option if you believe the share is going down. If you are correct on the direction of the movement, you can make a significant profit. If you are wrong, you may lose the premium that you paid.  

CFDs provide the ability to trade both long and short with ease. For Short Selling, push sell on your trading platform before you push buy. There are no complex rules to follow or different instruments to choose. CFDs are very simple to understand and trade.

Why does my head hurt when learning options?

Option pricing is extremely complex and not for the faint hearted.  It is affected by the share price, exercise price (strike price), volatility, time, dividends and interest rates.  The pricing of CFDs is very simple because it matches the underlying instrument, making a CFD simple to understand and begin trading. There are no complex pricing models to learn: if the share moves $1, so does the CFD.

When trading options, risk is limited to the initial investment (unless you write naked options where your risk is potentially unlimited), while CFDs carry theoretically unlimited risk. It is vitally important that a CFD trader manages their risk to ensure their survival in the CFD market.

Key Advantages of CFDs versus Options

• CFDs mirror the underlying performance of the stock or index you are trading 
• You can trade as little as 1 contract which controls one share CFD as opposed to 1 contract  with options controlling 1,000 shares 
• Options are incredibly challenging to learn whilst CFDs are easy 
• If you know how to trade stocks, then you know how to trade CFDs 
• There is no expiry date when trading CFDs. Options expire regularly 
• You have a considerably larger pool of opportunity to select from 
• CFDs allow you to better hedge your stock investments than options 
• If you hedge your stock portfolio using CFDs, you get paid every day you are short 

Key Disadvantages of CFDs versus Options

• There is no equivalent CFD product for writing options 
• Options literally give you a wide variety of trading strategies to choose from 

I am unable to say whether CFDs are the right instrument for you to trade. I personally believe they are a truly flexible trading instrument, which offers a wide degree of flexibility and choice to the active trader.

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Article source: Jeff Cartridge

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