QUITE A number of people who attended a seminar subsequently opened Contracts for Difference (CFD) trading accounts to use the equity derivative to profit from falling stock prices.
Instead of moaning over battered portfolios, the 120 or so who attended last Wednesday night’s seminar at the National Library looked for trading opportunities. CFD is an instrument offering leverage.
First introduced to Singapore five years ago by Phillip Securities, a CFD is an agreement to settle the difference in opening and closing prices of a stock chosen by the CFD trader.
CFD is an equity derivative which simulates buying and selling shares through SGX (the cash market), be it prices, queue volumes or trading hours.
Unlike the cash market though, the CFD trader’s counter-party is a market maker like Phillip Securities and not the Central Depository.
CFD may contribute to stock market activity when the market maker hedges against this exposure on the cash market.
An important point to note is finance charges of up to 8% p.a. of contract values are payable by a CFD client over the period that his CFD position remains outstanding, says Phillip CFD dealer Julia Teo.
This is in addition to Phillip Capital’s broker commission of 0.13%, the lowest among CFD market makers in town.
These financing charges are why the CFD is a short-term trading strategy for volatile stocks, and not for long-term value investing.
When do traders use CFDs?
(1) For leverage
Starting with a cash outlay of as little as S$3,000 in his Phillip CFD account, a CFD trader can buy or sell contract sizes totaling up to S$15,000 (20% initial margin or 5 times leverage).
(2) Extend holding period of trading without capital outlay
Unlike contra-trades in the cash market which need to be closed within 3-4 market days, CFD trades need only to be settled when there is a margin call should the CFD account fall into deficit.
Meanwhile, finance charges accrue from day to day, and a contract renewal broker’s commission is payable every 30 calendar days as long as the contract is kept outstanding.
Most CFD clients close their positions within the month, and many practice intra-day trading, says Julia.
(3) Using CFD to profit from falling stock price
For example, when OCBC Investment Research downgraded SGX to "hold" on 16 Oct, assume a CFD trader sold SGX at S$5.54.
Some 47 cents was knocked off SGX in the past 5 trading days and it closed at S$5.07.
Assuming our trader maxed out his leverage and sold 2,500 SGX shares at S$5.54 on 16 Oct using CFD, a simple calculation shows that his CFD account a week later at the close of Thu 23 Oct would be:
|Cash deposit||$ 3,000.00|
|Less Commisson||$ 26.75||0.13% of contract value with a minimum of $25 incl GST|
|Plus realised P/L|
|Plus realised credit/debit interest||$ 0.01||0.25% on margin excess|
|Less realised finance charges|
|Ledger Balance||$ 2,973.26||Cash less comm plus realised P/L and charges|
|Ledger balance||$ 2,973.26|
|Plus unrealised P/L||$ 1,175.00||Change in portfolio value is ($5.54 - $5.07) X 2,500 shares|
|Less unrealised finance charges||7-days interest-free financing|
|Equity Balance||$ 4,148.26||Ledger balance plus unrealised P/L and charges|
|Maintenance Margin||$ 2,535.00||20% of portfolio value, now at $5.07 X 2,500 shares|
|Margin Excess||$ 1,613.26||Equity balance less maintenance margin|
The trader’s margin excess of S$1,613.26 may be withdrawn without closing outstanding positions after settling unrealized interest charges.
However, if the stock price had risen 47 cents against his short position instead, the margin excess would have become a deficit of $1,206.74.
Margins are marked to market every day and CFD clients have two working days to top up any margin deficit.
CFD is a potent short-selling and leverage tool
Naked short sellers on the cash market, i.e. those who sell without borrowed scrip, are subject to ‘buying-in’ whereby the SGX closes the short position on the fourth market day after the short sale.
From 25 Sep 2008, SGX has imposed on traders a penalty of 5% on each naked short contract value, with the minimum penalty at S$1,000.
Since then, CFD has become more relevant than ever, even as falling stock prices have become a more and more predictable trend.
One participant at Phillip’s seminar told NextInsight he keeps a watch-list of stocks with negative news flow, something not too difficult to find in today’s gloomy markets.