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.