Contracts for difference

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6. Interest payments

When you trade CFDs, your account is either debited or credited with daily interest payments.

• If you hold a long CFD position, interest charges will be debited from your account.
• If you hold a short CFD position, interest charges will be credited to your account.

The charges are calculated daily on positions held overnight, and do not apply if you trade intraday (i.e. buy and sell within a single trading day).

The rate of interest debited/credited will be stated by your broker in its terms & conditions. Interest debited will often be set at a premium to the 1 month LIBOR (London Interbank Offered Rate), though other benchmarks may be used. Interest credited will often be set at a discount to the 1 month LIBOR.

Example of a long CFD

• You buy a CFD equivalent to 3,000 M&S shares at 400p. The contract value is £12,000.
• At the end of the first day, the shares drop 3p to 397p. The contract value is now £11,910.
• If the applicable interest rate is 6.5%, the interest debited from your account for this particular day will be £2.12 (£11,910 x 6.5%/365).

To get a feel for the level of interests charges, try changing the variables in the calculator below:

CFD interest charges LIBOR    % Premium/Discount (If discount put a minus sign in front of the figure, eg -2.5)    % Overnight contract value £    Overnight interest debit/credit £

Why do you have to pay interest charges? Well, one way of looking at it is that when you buy a CFD equivalent to £15,000 of shares, you are getting the economic benefit of that parcel of shares from your broker. You are 'borrowing' £15,000 from the broker, and should expect to pay interest on that loan.

The flip side is that if you hold a short CFD position on the same £15,000 of shares you are in effect 'lending' that money to your broker, and so you receive interest.

Example of interest received on a short position:

• You sell a CFD equivalent to 3,000 M&S shares at 396p. The contract value is £11,880.
• At the end of the first day, the shares rise to 402p. The contract value is now £12,060.
• If the applicable interest rate is 5%, you receive interest of £1.65 (£12,060 x 5%/365).

Don't worry if the rationale for interest charges is a little opaque to you. The important thing is that you realise that they are a cost of holding long CFDs and, over time, can outweigh other advantages like the lack of stamp duty. For this reason, CFDs are commonly used for short-term trading and are rarely appropriate for the long-term.

1. What are CFDs? 2. The benefits of CFDs 3. Initial margin 4. Variation margin 5. Commission costs 6. Interest payments 7. Dividends 8. Example of a long and short trade 9. Comparison of CFDs to share investing 10. Comparison of CFD trading to spread betting 11. Types of order 12. Stop losses 13. Strategies: Pairs trading 14. Strategies: Hedging an equity portfolio 15. Opening an account with a broker 16. Conclusion

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