Futures and CFDs are both types of derivative contracts, because their value derives from various underlying assets. Instead of buying or selling commodities, traders of futures and CFDs speculate on price behaviour without actually owning the commodities.
Derivative contracts can also be based on the value of stocks, indices, bonds and currency pairs. CFDs and futures are both highly leveraged financial products. Providers of these contracts allow traders to receive a large exposure with a small initial investment.
But what’s the difference between the two contract types?
A futures contract is an agreement to buy or sell a financial instrument (underlying asset) for an agreed upon price on a predetermined future date.
Futures are standardised contracts that specify the exact quantity, quality and location of a physical asset, as well as the delivery time. At its expiration, the contracts may be settled in cash, when money is debited from or credited to the parties’ accounts, or by physical delivery, when the parties have to make or take the delivery of the physical investment.
A contract for difference is an agreement to exchange the difference in asset value at the beginning of the contract and the end of the contract. The trader tries to predict the price movement correctly. If the trader foresees that the price will increase, he buys, or goes long. If he believes the asset value will go down, then he sells or goes short.
In a while, the party that predicted it right reaps the profit, or the price difference.
Futures vs CFDs: what’s the difference?
To begin with, the two derivative types differ in where they are traded.
Futures contracts are traded in official marketplaces, such as the CME Group, NASDAQ Futures Exchange (NFX), Euronext, Johannesburg Stock Exchange Derivatives Market and many more. This makes futures highly standardised trading instruments with fixed specifications. Only the settlement date differs from one contract to another.
In contrast, contracts for difference are over-the-counter (OTC) instruments. They are not provided by official exchanges but by brokers who define their individual terms. CFD providers organise a market for assets to trade, as well as create and disseminate prices in real time.
Spread is the difference between the buy price and the sell price of an asset.
Both futures and CFDs are traded with spread. However, in the futures market spreads are considerably small. CFD providers, in turn, often use the futures market to hedge their own positions, that is why CFDs are typically traded with a larger spread than that of the futures.
3) Contract size
Futures are traded on large exchanges and are designed to be used by large investment institutions. That’s why such contracts usually stipulate large minimum sizes.
For example, the minimum unit of one crude oil futures contract at COMEX is equal to 1,000 barrels. In comparison, the size of one crude oil CFD contract at Capital.com is 10 barrels. In this respect, contracts for difference are much more flexible and available for individual traders who cannot afford a larger exposure.
4) Flexibility of leverage
Leverage helps receive an exposure to bigger trades with a smaller amount of money deposited in the first place. This initial deposit is magnified, or leveraged, with profit or loss based on the total value.
Leverage for futures varies from one contract to another, but overall, it is not very flexible. The initial margin (the deposit minimum required to buy a futures contract) is determined for each futures type by a clearing house or an exchange. As usual, the initial margin is about 5-10% of the value of the futures contract.
The counterparty for a CFD trader is not an exchange, but a broker. A broker provides CFD contracts and thus has the power to set the value of initial margin. For individual traders, this means that there are options and they can choose any up to the maximum stipulated by the broker.
5) Expiration date
In the futures market, contracts always specify the dates upon which they expire.
This represents the date when, under the terms of the contract, the underlying asset has to be delivered at the price previously agreed. Expiration dates are set for each futures contract by the exchange which provides the market.
In fact, most futures are settled before expiration. Traders enter into futures contracts with no intention of taking a delivery. They just want to make a profit from price fluctuations in the market.
A contract for difference, in contrast, has no fixed future price or expiration date. You enter into a contract and liquidate it when the price of the underlying asset goes against you. The difference between the price at the beginning of the contract and the price at the end of the contract is your profit or loss.
Both types of derivative contracts are marked to market, meaning that they are re-priced each day. They have similar underlying assets, although commodities-based futures are more frequent. However, now that you know how CFDs differ from futures and can choose the contract type suitable for you.