Contracts for differences (CFDs) are becoming more popular in European countries as well as Australia, US, Japan and China. A CFD is an agreement between an investor and a business to exchange the difference between the opening and closing price of an underlying asset over time.
Many investors using platforms such as Interactive Investor are catching on to the potential of CFDS and spread betting, which allow access to the oil and gas market, without being subject to the costs involved with trading directly. Here’s a closer look at trading CFDs in oil and gas.
Oil and Gas CFDs
The World Energy Outlook 2013 Report published by the International Energy Agency (IEA) predicts that global energy demand will increase by one-third by 2035, driven by emerging and developing economies. The supply and demand of oil and gas can have huge impact on the prices and in turn influence global economic growth.
The fluctuations in oil prices make it an ideal commodity for trading. Although gas is not as heavily traded as compared to oil, its prices tend to be easier to predict. With this in mind, CFDs represent an easy way to gain exposure to the fuel and energy markets.
The two main products for crude oil CFDs are the US WTI/Light Crude traded on the New York Exchange (NYMEX) or the Brent crude trade on the Intercontinental Exchange (ICE). CFDs that are related to oil prices include the UK Oil and Gas sector CFDs, USA Oil and Gas sector CFDs, individual oil share CFDs such as Exxon Mobil and Royal Dutch Shell, and USA Natural Gas CFDs.
From as early as 1988, Brent CFDs has been a useful hedging instrument for industry participants. In the Brent CFD market, companies trade the difference between the dated Brent and a forward Brent price. In contrast to the futures markets, you can buy smaller contract sizes for CFD. Thus, CFDs act as a complement for the forward and futures markets. This is particularly useful for companies that depend on the price of oil as part of their business.
In addition to being used as a hedging device, investors are using oil CFDs as a tool for speculating on oil prices. Rather than physically trading in oil, CFDs enable individual investors to enjoy the benefits of leverage and lower transaction costs. Hence oil CFDs are a cost effective way to invest in the oil market.
Similar to oil CFDs, traders do not have to physically trade in natural gas directly, thus avoiding warehousing and storage expenses. In contrast to oil CFDs which is traded on the spot market, natural gas CFDs are usually traded on the futures market. Hence, natural gas CFDs enable traders to tap the gas futures market with lower investment sizes than that required on the futures market. In addition, traders enjoy lower commission and transaction costs and higher leverage.
Here’s an example of trading an oil CFD:
Based on your understanding of the fundamentals and technical research, you believe that Brent Crude Oil is undervalued and the position will rise. You decide to take a long position on oil CFDs. The quote offered by your CFD provider is $80.00 (bid) to $80.25 (ask). If you place an order for 500 oil CFDs at 3% margin, you would need $80.25 x 500 x 3% = $1,233.75 to open the CFD position. If the price rises to $82.50 to $83.00 and you sell the contracts, your profit will be $1,125.00 minus any interest charge if you hold the position overnight.
While oil and natural gas CFDs offer high potential returns, they also carry high level of risk and can result in losses that exceed your initial investment. Make sure you keep up to date with current political development relating to energy and gas producing countries, and fully understand the risks involved.