When it comes to financial instruments, there are a lot of similarities between options trading and CFDs. Both are derivative products that allow traders to speculate on the price movement of an underlying asset without actually owning the asset itself. However, there are also some critical differences between the two that Singaporean traders should know before deciding which one is right for them.
Underlying assets
The most obvious difference is the underlying asset that each contract is based on. An option contract gives the holder the right, but not the obligation, to buy or sell a specific security at a predetermined price within a certain time frame. Conversely, a CFD is a contract for difference based on an underlying asset’s price movement.
When you trade a CFD, you simply speculate on whether the underlying asset price will go up or down. There is no exchange of the asset itself.
Expiry date
Another key difference between the financial instruments of options and CFDs is the expiry date. An option contract expires on a specific date, at which point the warranty is void, and the trader will no longer have any rights or obligations under the agreement. A CFD, on the other hand, does not have a specific expiry date. Instead, it expires when the underlying asset’s price reaches the stop-loss or take-profit level the trader has set.
Leverage
Another key difference between the financial instruments of options and CFDs is leverage. Leverage is essentially a loan that the broker provides to the trader, which allows the trader to make larger trades than they would be able to without leverage. Options contracts usually have a fixed amount of leverage set by the exchange.
For example, the Chicago Board Options Exchange (CBOE) has a leverage limit of 4:1 for option contracts. For every SGD1 a trader has in their account, they can trade up to SGD4 worth of contracts.
On the other hand, CFDs offer variable amounts of leverage that the broker sets. Some brokers may offer as much as 200:1 leverage on CFD trades. For every SGD1 a trader has in their account, they can trade up to SGD200 worth of the underlying asset.
Margin
Margin is the amount of money a trader must have in their account to open a position. It is essentially a good faith deposit used to secure the contract. For options contracts, the margin is set by the exchange. For example, the CBOE requires a minimum margin of SGD5,000 for options contracts. CFDs have variable margins that the broker sets. Some brokers may require a minimum margin of just SGD100 to trade a CFD.
Settlement
The settlement of an options contract is the process by which the trader buys or sells the underlying asset at the predetermined price. The payment of a CFD is much different. When a trader enters a CFD trade, they enter into a contract with the broker. There is no physical exchange of the underlying asset and no delivery. Instead, profits and losses are settled in cash. If you long on a CFD and the underlying asset price goes up, you will make a profit. If the price goes down, you will incur a loss.
Pricing
The price of an options contract is based on the cost of the underlying asset and several other factors, such as time to expiration, volatility, and interest rates. The price of a CFD is simply the difference between the bid and ask prices. The bid price is how much you can charge for the underlying asset, and the asking price is how much you’ll pay when you buy it.
Tax implications
In Singapore, options contracts are subject to capital gains tax. Therefore, if you profit from your options trade, you must pay tax on that profit. CFDs are not subject to capital gains tax in Singapore because CFDs are not considered financial products under Singaporean law.
Regulatory environment
The Monetary Authority of Singapore (MAS) regulates the options market in Singapore. The MAS is the central bank of Singapore and is responsible for regulating financial markets in the country. The CFD market, on the other hand, is not regulated by the MAS. Instead, it falls under the regulatory oversight of the Securities and Futures Commission (SFC).
Financial Instruments Conclusions
In conclusion, while options trading and CFDs share similarities as derivative products of financial instruments, crucial distinctions exist.
Singaporean traders must know the varied characteristics from underlying assets, expiry dates, and leverage to margin requirements, settlement processes, pricing mechanisms, and tax implications. Options involve rights to buy or sell specific securities within a timeframe, while CFDs hinge on speculating asset price movements without ownership. Options contracts have fixed leverage ratios and set margins and are subject to capital gains tax regulated by the Monetary Authority of Singapore.
Conversely, CFDs offer variable leverage, flexible margins, and settlement in cash and are not subject to capital gains tax, falling under the oversight of the Securities and Futures Commission. Understanding these nuances is essential for traders to make informed decisions based on their financial goals and risk tolerance.
