/Should you Trade CFDs or Opitions
Should you Trade CFDs or Opitions

Should you Trade CFDs or Opitions

This may be one of the things that most new traders are asking themselves. Should they be trading forex via CFDs or should they use something like asymmetric instruments like options. This does really depend on the type of trader and their individual preferences.

However, there can be room for both types in a well-managed portfolio. Each of these instruments do have their pros and their cons. You have to decide whether you are willing to take the risk on certain instruments in order to garner the returns.

Before we look into which one you should be trading, we have to determine the main differences between the two types of instruments.

What is a CFD

A CFD (Contract for Difference) is a derivative instrument where the broker will calculate the difference between the opening and closing price of an asset at the end of the day. The broker will then adjust the clients position based on this difference.

The client can also either take a long or short position on the trade. They can go long which means they will gain if the price goes up during the day or they can go short which means they will make money if the price goes down during the day. You can see an example of a CFD below.

Example of a CFD

They are what are termed “delta one” products. This means that they react one for one as to how the price of the asset is reacting. They are also levered or margined instruments. This means that you can invest on a notional trade size which is much larger than you have available.

This is also why they are sometimes considered really risky instruments and why you should never trade them without stop losses and take profits.

If you are looking for a CFD provider that will allow you to trade on demo accounts then you could consider a broker such as markets.com.

What is an Option

An option is a financial instrument that gives the holder the right but not the obligation to buy or sell the asset at some point in the future (expiry time). These are asymmetric instruments which means that the payoff is not one for one.

There are two types of options. There is a call and a put option. A call option is an option that confers the right to buy the asset and the put option confers the right to sell. The cost to enter into the option is the option premium. You can see a visual representation below.

Option Payoff Example

These are naturally less risky than CFDs as you can only lose your initial investment. However, they cost money to enter and that optionality it the premium that you are putting up for stake.

Moreover, there are a number of option strategies that you can implement is quite broad. This is because of the payoff structure. It is not a simple straight line. You can implement strategies such as bear spreads, straddles and strangles.

If you are looking for the best broker to options with then you could consider IQ Option. They have one of the best option platforms on the market. There are a number of online IQoption reviews that can give you an indication of the platform.

Which one should I trade?

If you want to trade simple long / short strategies then you could consider trading CFDs. These levered instruments are simple and they cost nothing to open.

However, If you are considering investing in a CFD, you should make sure that you make use of regular stop losses and that you don’t take too much risk unnecessarily. These instruments are levered so your capital is at risk.

If, however, you want to try a more sophisticated strategy that makes use of asymmetric payoffs then options are indeed for you. They merely require the investment of the premiums. Yet, this will be the maximum that you will lose as the payoffs are defined.

Also keep in mind that options have expiry times so you will need to know exactly when to execute these options. The target is for the payoff to occur when you have the expiry of these options.

Conclusion

In the end, whether you trade options or CFDs, you have to have some sort of a strategy when you are doing it. You cannot merely enter trades in the hope that they will result in profits. You need to becomes will versed in the disciplines of fundamental and technical analysis.

Lastly, you also have to have a strategy when it comes to managing your money. You have to know when to stop trading and cut losses or realize your gains. This can indeed be tricky as emotion does often play a factor. However, is you keep disciplined and only trade according to the rules that you have set out then you are likely to succeed.

Patrick used to work for a large financial institution in Toronto. He traded Forex on G10 pairs for the flow. He know helps fellow traders find their niche online