I notice that everyone seems a little confused on this. Therefore to settle the debate for you all, the difference between DMA and market makers is irrelevant. It only makes a difference when the underlying market is closed.
I hope some of you at least will find the following explanation helpful:
A CFD is simply a type of futures contract. To be more particular it is a futures contract without an expiry date.
A CFD effectively obliges the you to buy or sell the underlying asset at some unspecified date in the future (via cash settlement not actual delivery).
Consider a standard futures contract. The futures contract has a futures price because the contract has a predetermined expiry date.
A CFD differs because the expiry date is indefinite so no ‘futures price’ can exist. To solve this problem the ‘settlement price’ of the contract is simply set to the spot price of the underlying asset in the market. The interest advantage of the contract is then settled on a daily basis.
I.e. The ‘advantage’ of buying something in the future is not having to pay for it now: For a standard futures contract this advantage is calculable and built into the futures price. For a CFD however this is not possible hence the daily financing charge on the implied borrowing requirement.
The present value of buying in the future must be the same as the present value of buying in the present (otherwise an arbitrage opportunity will exist). Therefore the CFD price (whether DMA or otherwise) will be arbitrage enforced so long as the underlying market remains open.
Consider the following: The CFD price at inception is set at zero (it costs nothing to enter) therefore the CFD must have zero value to both parties at this point (otherwise arbitrage).
For a CFD, the only ‘settlement price’ that satisfies this equality is the current spot price of the underlying asset.
Therefore a CFD market maker offering a settlement spread that does not cover the underlying spot price will be taken to the cleaners by arbitragers.
For example a CFD broker offering a spread that is above the market spot will be continually sold by arbitrageurs until forced to lower the spread.
Alternatively if the spread was below the market spot then arbitrageurs would continually buy the CFD, Clearly the only price at which arbitrageurs would be disinterested is when the spread was centred over the spot price.
In the absence of confounding factors such opportunities rarely exist (in general CFD prices are efficient so long as the underlying market remains open).
I’ve also read a few posts regarding CFD’s on futures. A CFD on a future is somewhat nonsensical as a CFD on a future is quite simply a future.
I hope some of you at least will find the following explanation helpful:
A CFD is simply a type of futures contract. To be more particular it is a futures contract without an expiry date.
A CFD effectively obliges the you to buy or sell the underlying asset at some unspecified date in the future (via cash settlement not actual delivery).
Consider a standard futures contract. The futures contract has a futures price because the contract has a predetermined expiry date.
A CFD differs because the expiry date is indefinite so no ‘futures price’ can exist. To solve this problem the ‘settlement price’ of the contract is simply set to the spot price of the underlying asset in the market. The interest advantage of the contract is then settled on a daily basis.
I.e. The ‘advantage’ of buying something in the future is not having to pay for it now: For a standard futures contract this advantage is calculable and built into the futures price. For a CFD however this is not possible hence the daily financing charge on the implied borrowing requirement.
The present value of buying in the future must be the same as the present value of buying in the present (otherwise an arbitrage opportunity will exist). Therefore the CFD price (whether DMA or otherwise) will be arbitrage enforced so long as the underlying market remains open.
Consider the following: The CFD price at inception is set at zero (it costs nothing to enter) therefore the CFD must have zero value to both parties at this point (otherwise arbitrage).
For a CFD, the only ‘settlement price’ that satisfies this equality is the current spot price of the underlying asset.
Therefore a CFD market maker offering a settlement spread that does not cover the underlying spot price will be taken to the cleaners by arbitragers.
For example a CFD broker offering a spread that is above the market spot will be continually sold by arbitrageurs until forced to lower the spread.
Alternatively if the spread was below the market spot then arbitrageurs would continually buy the CFD, Clearly the only price at which arbitrageurs would be disinterested is when the spread was centred over the spot price.
In the absence of confounding factors such opportunities rarely exist (in general CFD prices are efficient so long as the underlying market remains open).
I’ve also read a few posts regarding CFD’s on futures. A CFD on a future is somewhat nonsensical as a CFD on a future is quite simply a future.
