The Benefits Of CFDs Compared To Futures And Options: A Quick Guide In 2023

As a trader or investor at the beginning of your journey, you face a problem of choice.

The markets, over the course of history, have produced an array of financial products. The thoughtful investor will need to look at stocks, exchange-traded funds (ETFs), index funds, bonds, currency pairs, options, futures, forwards, swaps and contract-for-differences (CFDs) just to get started. Despite the seeming difficulty, the choosing process can be structured more when the investor considers their risk appetite and their time horizon. 

Those who take a long-term view of the market tend to opt for fundamental financial instruments such as stocks, ETFs and indices, using more complex instruments as a hedge. Those who seek to profit from short-term fluctuations and who possess a greater risk appetite tend to choose more complex financial instruments like options, futures and CFDs as means to generate market-beating returns.  

There is a clear distinction between the two groups: options, futures and CFDs are financial “derivatives,” a class of products that do not grant their owners ownership over an asset (like a stock) or a group of assets (like an ETF) but whose price fluctuates as a result of the price movements of the underlying asset. For speculators, derivatives offer a convenient method to trade price fluctuations with leverage.

The Most Common Derivatives: Futures, Options And CFDs

As an active derivatives-based speculator, futures, options and CFDs are the most popular financial products, but each has its own benefits and deficits. 

Options contracts are agreements between two parties that give the buyer the right, but not the obligation, to buy or sell an underlying asset at a predetermined price (known as the strike price) within a specific time frame. The buyer of an option pays a premium to the seller for the right to exercise the option. 

Futures contracts, on the other hand, are legally binding agreements between two parties to buy or sell an underlying asset at a predetermined price and date in the future. Unlike options contracts, most futures contracts are mandatory and must be executed on the specified date, regardless of the market price. 

CFDs are derivative instruments that allow traders to speculate on the price movements of underlying assets without owning the assets themselves. When trading CFDs, the trader agrees with a broker to exchange the difference in the price of the underlying asset between the opening and closing of the contract. There are no time constraints on CFDs.

All three derivatives are popular amongst traders because they offer leverage, enabling them to trade with larger positions than they could with their capital. Leverage is possible because of margin trading, which relies on the broker’s provision of temporary loans for the duration of a trade. Short selling is also made easy with these derivatives, allowing traders to profit on price fluctuations to the downside as well the upside. 

There are clear differences between the products, however. The pricing on options contracts, for example, is a very complicated process involving many factors aside from the price of the underlying asset. This complicates backtesting results and makes it exceedingly difficult to manage risk. This risk makes CFDs and futures a more likely destination for most speculators, but options can still offset the risks above if used in the correct market conditions. 

The Benefit Of CFDs Over Futures And Options

The prices of CFDs and futures contracts have a far more linear relationship with the underlying asset’s price than options contracts. 

For example, if the underlying asset moves $1, traders using CFDs and futures contracts will know that the CFD contract will, say, move $12 and the futures contract will move $15 in response. With options contracts, there’s no knowing with full certainty where the price of the contract will be based on only the movement in the price of the underlying asset. 

Despite sharing a slight risk-management advantage over options contracts, CFDs and Futures differ in four central ways: 

1. Futures contracts are traded on exchanges, and their terms and conditions, such as the size of the contract, the delivery date and the settlement method are predetermined and regulated. In contrast, CFDs are over-the-counter (OTC) contracts between traders and brokers that allow traders to speculate on the price movements of underlying assets without owning the assets themselves.
2. Futures contracts are subject to margin requirements, which means that traders need to deposit a certain amount of money, known as margin, to initiate and maintain a position. The margin requirement is typically a percentage of the total value of the contract and serves as collateral for the trade. CFDs also require margin, but the margin requirement is typically lower than that of futures contracts, allowing traders to take larger positions with less capital.
3. Futures contracts have standardized expiration dates and settlement methods. Upon expiration, futures contracts are settled by the delivery of the underlying asset or in cash. In contrast, CFDs have no fixed expiration date and are typically settled in cash. Traders can close their positions at any time before the contract's expiration date, allowing for more flexibility in managing trades.
4. Futures contracts are subject to exchange fees and other regulatory costs, while CFDs are typically subject to bid-ask spreads and other trading costs charged by brokers. The trading costs for CFDs can vary significantly among brokers, so it is essential to research and compare fees before choosing a broker.

For traders curious about venturing into CFDs, picking the right broker is essential. One broker with excellent potential is FOREX.com, a leading brokerage platform that offers up to 3,000 CFDs on markets including forex, indices, commodities and stocks. One of the most attractive features of trading with FOREX.com is their $0 commission offering for stock CFD trading, which means that traders can trade CFDs without worrying about incurring high trading costs!

FOREX.com offers a user-friendly platform, extensive educational resources, and a wide range of analytical tools to help traders make informed decisions. Whether traders are new to CFD trading or experienced professionals, FOREX.com provides a robust and reliable platform to trade CFDs and take advantage of market opportunities.

Click here to learn more about trading CFDs with FOREX.com.

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