Charles Schwab Contracts for Difference (CFDs)

 

NB: This document was produced in 2003. Since then Charles Schwab's UK operations have been taken over by Barclays Stockbrokers. The specific details relating to Schwab's CFD offering therefore no longer apply but the general stuff does!

 

 

What are CFDs?

 

CFDs are so called because they are an agreement between the investor and a third party provider to exchange the difference between the opening and closing price of a contract. You predict whether an equity price will rise or fall and invest an amount of money against this prediction. If your prediction in the direction of the price movement proves to be correct you will make money, if not you will lose. Each party involved in the contract is described either as the short party or the long party. The long party makes money if the share price goes up. The short party makes money if the share price goes down. You the investor make the distinction as to whether you are trading short or long based on whether you predict prices will rise ( going long) or fall ( going short).

 

 

What are the benefits?

 

·        Since no actual shares are traded, CFDs are exempt from the 0.5% stamp duty that applies to normal share purchase

 

·        CFDs are geared investments. Typically only 10% of the total value of the trade needs to be placed on deposit. This creates the potential for achieving very substantial returns

 

·        By going short a CFD you can benefit from falling share prices

 

·        CFDs are offered on major foreign shares as well as UK ones

 

·        CFDs are offered on major indices (e.g. FTSE 100, Dow Jones) as well as individual shares

 

·        By paying an extra fee (0.25% for shares) it is possible to set a guaranteed stop loss. This would prevent large losses in the event of a major adverse move.

 

 

What are the drawbacks?

 

·        You don't own the shares so there are none of the associated rights that come with share ownership (e.g. voting on resolutions, company perks where available)

 

·        CFDs are geared investments. It is possible to lose many times your original stake. It is necessary to monitor positions regularly and to be able to respond to margin calls to provide additional cash to the account if losses mean that you no longer have enough cash to cover the margin requirement

 

·        If you are long a CFD then by putting up 10% margin you are effectively borrowing the other 90% from the broker. Charles Schwab charges daily interest on the whole amount of long positions at an annualised rate of LIBOR + 1.5%. Conversely, they pay you interest on the whole of the amount of short positions at LIBOR - 2.5%.

 

·        Theoretically, a short position can sustain infinite losses. They can certainly suffer losses several times the underlying equity amount whilst long positions can never lose more than 100% of the underlying value

 

 

What CFDs do Charles Schwab offer?

 

UK shares (FTSE 350 only)

US shares > $500m market cap

Euro shares > €500 market cap

The following indices:

FTSE 100

DAX 30 (Germany)

MIB 30 (Italy)

Dow Jones

CAC 40 (France)

Euro STOXX 50

S&P 500

Swiss Market

Nikkei Dow 225

NASDAQ 100

IBEX 35 (Spain)

Hang Seng

 

 

What are the commission charges?

 

Commissions for UK shares are 0.15% of the underlying equity value subject to a minimum of £17.50. For US and Euro shares the fees are 0.25% with a minimum of $30.00 / €30.00 respectively.

 

There is a flat fee structure for index trades, e.g. £12.50 for the FTSE 100, $19.50 for the US indices. There is also a further charge in the form of a bid/offer spread. E.g. for the FTSE 100 this is 6 points and if the FTSE was at, say, 4250 then you could buy the CFD for 4253 and sell it for 4247.

 

 

Would we want to use CFDs?

 

No, not really. They are most suitable for relatively short term positions where the gearing helps to make fairly small price moves sufficiently profitable. The finance charges for long positions can become expensive if held for a long time.

 

There is always the chance that we may wish to short a share or index at a future date, possibly as a hedge against other portfolio holdings but apart from that I cannot think why RSIC would want to use them.