Example – CFD vs. Traditional Investment
Suppose that stock in Company X is currently trading at 345p on the London Stock Exchange, and investor A and investor B both believe that it is undervalued. Trader A decided to call his broker and purchase 10,000 shares of Company X. Trader B decides to purchase a CFD for a 10,000 shares of Company X. First we will look at the costs incurred by each trader. (Assume a commission charge of 1%, a stamp duty of 0.5% and a margin requirement of 5%)
Trader A: 10,000 X 345p = 345,000p
Commission Charge: 345,000p X 1%= 3,450p
Stamp Duty: 345,000p X 0.5% = 1,725p
Total transaction cost: 350,175p
Trader B: 10,000 X 345p = 345,000p
Margin Requirement: 345,000p X 5% = 17,250p
Commission Charge: 345,000p X 1%= 3,450p
Total Transaction cost: 20,700p
Notice that even though both traders are exposed to profit and loss on the same amount of shares at the same price; the cash needed for trader A's transaction was 330,000 p more than that of trader B.
One month later, both traders close their positions in Company X, at a stock price of 358p. Now we will look at how much they earned.
Trader A: Sells 10,000 shares at 358p, with 1% commission charge.
Proceeds from sale: 10,000 X 358p = 358,000p
Gross Profit: 358,000p – 345,000p =13,000p
Less Sale commission: 358,000p X 1%= 3,580p
Less Purchase commission: 345,000p X 1% = 3,450p
Less Purchase Stamp Duty: 345,000p X 0.5%= 1,725p
Total profit from investment: 4,245p
Trader B: Sells 10,000 shares at 358p, with 1% commission charge.
Proceeds from sale: 10,000 X 358p = 358,000p
Gross Profit: 358,000p – 345,000 =13,000p
Less Sale commission: 358,000p X 1% = 3,580p
Less Purchase commission: 345,000p X 1%= 3,450p
Total Profit from investment: 5,970p
As we can see from the figures presented above, trader A earned a return on his investment of 1.23%; where as trader B earned an ROI of 28.84%. This was found by dividing the initial investment by the total profit.
