Swaps and overnight financing

A position that is closed within the trading day carries no financing at all. A position that is still open when the day rolls over carries an adjustment, credited to or debited from the account, and it repeats for every night the position survives. The adjustment is usually called a swap, sometimes an overnight financing charge and occasionally a rollover charge, and all three names describe the same entry on the statement.

It exists because of the gap between what a contract is worth and what has been posted against it. A CFD is opened against a margin requirement expressed as a percentage of the contract's notional value, which means the whole notional value is exposed to the market while only a fraction of it has been funded. The remainder is effectively carried, and carrying money has a price. That price is what the nightly adjustment settles. Losses on the position, it is worth restating, are calculated on that same full notional value and are not limited to the amount deposited.

Where the rate comes from 

In a currency pair the arithmetic is unusually transparent, because a currency position is two positions at once. Holding one currency against another means being long the interest rate of the first and short the interest rate of the second. The financing adjustment is the difference between those two rates, applied to the notional value of the position for one night. Where the currency being held pays more than the currency being borrowed, the difference is a credit. Where it pays less, the difference is a debit. The mechanism is symmetrical and the sign follows the rates rather than the direction of the trade.

On instruments that are not currency pairs the same idea is expressed as a cost of carry. A share or index position is financed against a short term benchmark rate for the currency the instrument is quoted in, plus or minus a spread the firm applies. The convention that follows from that is worth knowing: on a long position the benchmark and the spread work in the same direction and the adjustment is almost always a debit, while on a short position the benchmark works one way and the spread the other, so a short can be credited or debited depending on where the benchmark sits relative to the spread.

Commodity and index contracts written on futures behave differently again, because there is no interest rate to reference. The adjustment there reflects the shape of the futures curve rather than a financing rate, which is a separate mechanism with its own guide.

The arithmetic of one night 

The calculation applies an annualised rate to the notional value of the position and divides it down to a single day. Two conventions vary between firms and instruments: the day count basis, which is either three hundred and sixty or three hundred and sixty five days depending on the currency, and the point in the day at which the position size is measured. Both are published in the contract specifications, and both change the answer by a small amount rather than a large one.

The final row is the part that is easy to miss. The firm's spread is applied in the same direction on both sides, so it reduces a credit and increases a debit. That asymmetry is why the two sides of the same instrument do not net to zero, and why a pair of offsetting positions in the same instrument held overnight at two different brokers still costs money.

Why it accumulates quietly 

A single night's adjustment on a modest position is small enough to disappear into the noise of a daily statement, which is precisely what makes it worth measuring. It repeats every night the position stays open, it is charged on the notional value rather than on the balance, and it is unaffected by whether the position is currently ahead or behind. A position that has been open for a quarter has carried the adjustment roughly ninety times, and a position that has moved very little over that period may nevertheless be materially behind because of it.

The credit side is the mirror of the same effect, and it has a name of its own. A position held specifically because the financing runs in its favour is a carry trade, and it is one of the oldest strategies in the currency market. The literature on it is consistent on one point: the accumulated credit is small relative to the price movement the position is simultaneously exposed to, so a carry position is a currency position that happens to pay rather than an income instrument that happens to move.

Published, and variable 

Swap rates are published per instrument and per direction, and they change. They move when the central bank rates behind them move, they move when the funding market a firm sources its own liquidity in moves, and they can move without either of those when the firm revises the spread it applies. A rate read once and assumed to hold is a reasonable approximation over a week and a poor one over a quarter.

The units they are published in vary too. Some tables state a rate in points of the instrument's price, some in the account currency per lot, and some as an annualised percentage. Points and money per lot both depend on the contract size, so a table read in one unit and applied as though it were another produces an answer that is wrong by the contract size. The unit is stated in the header of the table, and it is the first thing to read on it.