Contracts for difference (CFDs) and spread betting are two of the most popular leveraged financial plays in the U.K. But while spread betting is legal only within the confines of the U.K., CFDs are a global trading method enjoyed by millions of people (but are still illegal in the U.S.). While most financial literature focuses on the differences between these two types of leveraged trading, there are quite a few similarities. At sites like easyMarkets and others, traders can partake of buying and selling CFDs and placing spread bets on thousands of different commodities, shares, currencies and indices. Here’s a summary of the key ways in which CFDS and spread bets are alike and different, along with a general definition of each type of trading:
What are CFDs?
In its most simple form, a CFD is a derivative contract, meaning that the two parties need not own the underlying shares. The seller simply agrees to pay the buyer the price differential on a particular asset. The price difference is measured as the rise or fall in price between the time the contract is made and when it expires. If the price goes up, the seller has a loss. If the price goes down, the seller shows a profit.
What are Spread Bets
Spread bets are financial derivatives in which parties essentially make predictions, or bets, on whether a particular underlying stock or security will rise or fall in price. Specifically, participants predict whether the price direction will sink below the bid or rise above the ask price.
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Both forms of speculating are popular in the U.K., and both are forms of derivative trading because participants are able to use leverage. Both CFDs and spread bets allow profits and losses without the holder of the contract or bet having to own any of the underlying assets. All trading is purely speculative. As well, both are financial transactions that can be done “on margin.” In other words, you need only have a small fraction of the total contract or bet amount in your account in order to trade. Calculating profit and loss is very similar too. Participants multiply their stake or number of unites by the amount of price difference at entry and exit. Both types of trading can include holding costs, and traders can choose to go long or short depending on their beliefs about how prices will change.
With spread bets, there are no stamp duties or capital gains taxes, but with CFDs, users must pay capital gains taxes. Spread betting is only open to U.K. and Irish citizens, but CFDs are available worldwide, except in the U.S. There are no commissions on spread bets but with CFDs, traders pay a commission in addition to whatever the spread charge is. Another key difference is this: Even though traders of CFDs must pay capital gains tax, they can also use any losses to offset other tax liabilities. Spread bettors don’t pay capital gains, but likewise are not able to use their losses to offset tax liabilities.