CFD

A CFD is a deal with your broker: when you close the position, one of you pays the other the difference between the opening and closing price of some underlying — a share, index, currency pair or commodity. Price rose and you were long: the broker pays you the difference. Price fell: you pay.

You never own the underlying — no shares, no voting rights, no exchange trade. It is pure price exposure with heavy leverage: with 10% margin, €1,000 controls €10,000 of exposure, so a 5% market move is a 50% move on your money.

CFDs are marketed on convenience: one account, thousands of markets, easy short selling, tiny ticket sizes. Regulators' data shows the sobering flip side: the large majority of retail CFD accounts lose money — a statistic brokers in Europe must print on their own ads.

The cost stack

• Spread: the broker's quote is wider than the underlying market — paid on every round trip.
• Overnight financing: long positions are charged (benchmark rate + ~2.5–3%) per day held; shorts may earn or pay. Holding a CFD for months costs far more than owning the asset.
• Currency conversion fees on foreign underlyings, plus occasional guaranteed-stop premiums.

Margin mechanics

Positions are marked continuously. Fall below maintenance margin and the broker issues a margin call — or simply auto-liquidates your position at market. EU rules cap retail leverage (e.g. 30:1 FX majors, 5:1 single stocks), mandate negative-balance protection, and ban bonuses.

Who is on the other side?

Your counterparty is the broker. Some hedge client flow in the underlying ("A-book"); many internalise it ("B-book"), meaning your loss is literally their revenue — the conflict of interest behind much of the sector's regulatory history. The US bans CFDs outright; the UK/EU permit them with restrictions.

Pricing: a rolling forward at zero basis

Economically, a CFD is a total return swap in retail clothing: price return exchanged against financing, reset continuously. Fair pricing is spot tracking with a financing accrual:

where \(Q\) is size, \(m\) the broker's financing markup, and cash dividends are credited to longs / debited from shorts on ex-dates (CFDs are price-return instruments with manual dividend pass-through).

The broker's book

A CFD provider runs a risk engine over aggregate client positions: internalise offsetting flow, hedge net residuals in futures/cash, and manage the B-book with statistical confidence that leveraged retail flow loses to spread + financing over time. Its risk is gap events (SNB 2015 broke several brokers when negative balances exceeded client equity) — hence guaranteed-stop pricing as a barrier-option premium:

Regulatory economics

Leverage caps are set from close-out probability models: with volatility \(\sigma\) and leverage \(L\), the probability of hitting a 50% margin close-out within horizon \(T\) grows with \(L\sigma\sqrt{T}\) — the basis for asset-class-specific caps.