Contract for difference (CFD)

An agreement between two parties on a reference price for a market that neither intends to hand over. One side gains if that price is higher when the agreement ends, the other if it is lower. Nothing is exchanged when the contract opens. When either party closes it, the difference between the closing and opening prices is multiplied by the size of the contract and that amount passes from one side to the other. The name is unusually literal: a contract, between two named parties, that settles a difference.

Price multiplied by size gives the notional value, and the notional value is what profit and loss are calculated on. The contract is not funded in full: the counterparty requires a percentage of the notional value to be posted as collateral for as long as the contract is open, and that percentage is the margin requirement. Because the difference is calculated on the full notional value while only a percentage of it has been posted, a loss is measured against the whole contract, can exhaust the collateral entirely, and is not limited to the amount deposited. A favourable move is measured on exactly the same basis and to exactly the same degree.

The other party is the broker, not an exchange and not another client, which makes a CFD an over the counter contract. It can only be closed with the firm that wrote it, there is no secondary market for it and no certificate to transfer, and a position held past the daily cut off carries a financing adjustment for as long as it remains open. Buying the underlying outright is a different transaction: the full price is paid, title passes, and the rights of ownership come with it.

Two arguments about the instrument are genuinely unsettled. The first is whether a CFD is usefully described as a wrapper around the underlying, which is accurate over a short hold and diverges the longer financing accrues. The second concerns the counterparty: a firm that retains rather than hedges its exposure sits on the opposite side of a client's result, which critics call a structural conflict that disclosure does not remove, and which firms answer by pointing to netting across a whole client book and to external hedging. Neither answer settles the matter on its own.