This strategy is not allowed in the United States.
Contracts for differences (CFD) is a trading strategy where the differences in the settlement between the open and close prices are cash-settled. In other words, investors use CFDs to make price bets as to whether the price of the underlying asset will rise or fall. With CFDs, there is no delivery of physical goods.
This hedge requires an over-the-counter bet with nearly unlimited risk.
Due to high volatility risk, the protection can be horrible or excellent.
CFDs use leverage so investors put up a small percentage of the trade. However, the total cost is unknown at time of contract.
An investor has futures contracts to buy 500 barrels of oil for $25,000 ($50 per barrel). They are worried since the market price just went to $40 per barrel. To protect their holdings, they purchase a contract for difference (CFD).
To execute the CFD, the broker requires 5% down. The investor buys 500 barrels of oil for $20,000 ($40 per barrel). Only $1000 is paid to cover the 5% down payment.
Two months later, the oil market is trading at $45 per barrel. The investor exits the position with a profit of $5 per barrel or $2500. This strategy helps negate their loss on the original futures contracts (-$2500 futures + $2500 CFD = 0). No oil from the CFD is delivered due to the cash settlement.
© 2020 Todd Moses
The strategies discussed are for illustrative and educational purposes and are not a recommendation, offer, or solicitation to buy or sell any currency or to adopt any investment strategy. There is no guarantee that any strategies discussed will be useful. Todd Moses is not a licensed securities dealer, broker, or US investment adviser or investment bank.