CFDs vs options: what are the differences?

When trading online, investors may be looking to choose between CFDs vs. options. Both are financial derivatives, but each has specific characteristics and differences that investors should understand.

While they may seem very similar in some respects, they actually have peculiarities that make them suitable for different types of traders. Let's see what the advantages of these investment instruments are and which one may be best for trading.

Contracts for Difference (CFDs) are derivative financial instruments, private contracts between a broker and a trader built on an underlying asset. These can be various types of assets, including a stock, an index, a commodity or a Forex currency pair. CFDs do not have an expiry date but if you hold the position beyond the trading day you have to pay overnight costs.

In CFDs trading, it is possible to speculate on any direction of the price of an asset, without actually owning it, by opening upward (long) or downward (short) positions. The position can be opened and closed even after a few minutes, or held for several hours, days or weeks depending on your trading strategy.

Investing with CFDs involves the payment of a fee called a spread, as it is calculated as a percentage based on the difference between the bid and ask price. To increase the scope of the investment, it is also possible to use leverage, but it is important to use this instrument carefully, as it also carries greater risks in the event of a loss.

Advantages of CFD trading:

• it is possible to trade CFDs on many types of assets;
• commissions are generally low;
• you can speculate on small price movements;
• you do not have to buy the underlying asset;
• it is possible to start CFD trading even with small capital.

Options are also financial derivatives, again in the form of a contract. However, the operation mechanism of this type of contract is different from CFDs. With option trading, you obtain the right to buy or sell at a certain price, a value that is kept fixed for a certain period of time.

Call options are buying, while put options are selling. When you open a position you have to pay a premium, i.e. a share of the value of the option to be paid to the broker to cover the position in case of loss. Options have an expiry date, when you can exercise your right to buy or sell, or let the option expire and lose the premium.

Options are different from futures because they do not oblige the execution of the contract on the expiration date, but instead just offer the possibility of doing so. Options like CFDs are also built on an underlying asset, such as shares and commodities, with the value of the option replicating the price of the underlying asset, but in a less symmetrical manner than CFDs. Options trading serves both to speculate on asset prices and to hedge long-term positions.

Advantages of options trading:

• the risk is fairly low with the maximum loss equalling the value of the premium;
• options can be used to hedge other investments and positions;
• you can create customised strategies according to your objectives.

Now let's look at the main differences between options and CFDs. Options have a non-binding expiry date, allow you to become the owner of the asset and involve limited risks. They also have low trading costs and can be used to defend other open positions.

Unlike options, CFDs have no expiry date, you can choose from a wide range of markets and use leverage, which works very much like the underlying asset. They are also simpler instruments to understand, whereas options can be more complex, especially for a novice trader.

When choosing between CFD trading vs. options, it is important to assess all these aspects, also considering your needs, level of expertise and the type of investments you want to make. The decision between options and CFDs is entirely personal, but it is possible to set out some useful tips to facilitate this choice.

Overall, options trading tends to be more suitable for traders with more experience and skills, and who may be better placed to know which strategies to use to trade in all market conditions. CFDs trading may be more suited to novice traders, those who prefer a simple and intuitive tool for investing and those who wish to trade on a wide choice of markets.

With FinecoBank you can trade CFDs and options, taking advantage of modern web and mobile platforms, low commissions, and access to 26 global markets with over 20,000 international financial instruments available.