CFDs vs options: what are the differences?

What’s the difference between CFDs and options?

The difference between contracts for difference (CFDs) and options trading lies in how each contract works.

• With options, you're buying or selling the right (but not the obligation) to trade an asset at a fixed price by a certain date
• With CFDs, you're agreeing to exchange the variation in the price of an asset from when you open your position to when you close it
  

Both enable you to go long and short on financial markets without taking ownership of any assets. However, they fit different strategies, require different skills to trade, and come with their own unique rewards and risks. CFDs are considered more flexible since you can trade on several underlying markets, including options.

Options trading basics

An option is a financial derivative, and also takes the form of a contract. But instead of agreeing to exchange the difference in an asset's price, you're buying or selling the opportunity to trade it at a fixed price for a set period.

We offer two ways to trade options:

1. US-listed options: traditional options contracts traded on US exchanges. They can be exercised, potentially resulting in ownership of the underlying asset
2. OTC options: speculate on option price movements using spread bets or CFDs without owning the underlying contract

Let's look at an Apple (AAPL) example. If you believe that Apple stock is going to go up from its current level of $290, you might buy an option that enables you to purchase it at $295 at any point in the next month. If Apple rises above $295, you can exercise your option and buy it at a reduced price.

To get the option to buy Apple at $295, you'll pay a premium. If your option never becomes profitable, you can let it expire and the premium is all you’ll lose. But you’ll need to make more than the cost of the premium for the trade to earn a profit.

When you buy an option that turns to profit as the underlying market rises in value, it’s referred to as buying a ‘call’ option. But you can also use options to go short – these are called ‘put’ options. Buying a put enables you to sell a market at a fixed price for a set time. When you buy a call or a put option, your risk is fixed at the option premium (the cost of buying the option).

As well as buying options, you can sell them (known as ‘writing’ them). If you write a call, you open a short position. If you write a put, you open a long position. You’ll receive a premium when selling an option – but your risk is potentially unlimited.

An option’s premium will move up and down to reflect the likelihood that the contract will become profitable before it expires. This enables traders to use them to speculate on markets without ever exercising their contact and taking ownership of the underlying asset.

Find out more about how options work, or open a live account to start trading them now.

CFD trading basics

A CFD is also a financial derivative in which you agree to exchange the difference in an asset's price from when you open your trade to when you close it. You can buy a CFD to speculate on upward price movement or sell one if you think a market’s price is heading down. How much you make or lose on each trade is determined by how much the underlying asset moves.

Let’s return to our AAPL example. Say you believe that Apple stock is going to go up from its current level of $290, so you buy an Apple CFD. If you close your position when Apple is above $290, your CFD provider will pay you the difference in its price from when you opened your position to when you close it. If Apple's price fall below $290, you'll incur a loss.

Alternatively, you could have sold your Apple CFD at the outset. If you sell Apple at $290 and close your position at $280, you receive $10. If you close it at $300, you lose $10.

Like traditional stock trading, you pay commission to open a share CFD trade. So you'll need Apple shares to move by more than the costs of your position to make a profit.

CFDs aren't limited to stocks, though. You can use them to buy and sell currencies, indices, commodities and more. For these markets, you'll pay for your position via the spread.

Open a live IG account to start trading CFDs today.

Why trade options?

Limited risk (when buying)

When buying a call or a put option, your risk is capped at the price you paid for the premium. If the underlying market swings in the opposite direction to your trade, you can just let your option expire and you only lose the premium. In a CFD trade, your losses will grow as the market moves against you.

However, when selling options, the risk can be much greater, potentially unlimited for certain strategies.

Advanced strategies

You can use a mix of call and put options – or of buying and writing contracts – to unlock advanced trading strategies. Some strategies enable you to trade on volatility instead of price direction, or even speculate on flat markets.

Hedging

Many investors use options to hedge against potential drops in their portfolio. For example, if you own shares, you could buy put options to protect against a potential market crash. Say, for example, that you own 100 Microsoft shares, and you're worried about a possible upcoming market crash, but you don't want to sell your shares just yet.

You could buy a put option to sell 100 Microsoft shares at their current level, reducing your losses if Microsoft crashes. If the stock doesn’t fall, you just lose the premium you paid for the option.
You can also use CFDs to hedge, however. Using the same example, you could sell 100 Microsoft share CFDs. Then, any fall in your portfolio will be cancelled by a rise in your CFD position.

Why trade CFDs?

Similarity to the underlying market

CFD trading is designed to mimic trading each underlying market relatively closely. Buying or selling an Apple CFD, for example, means that you’re speculating on the price movements of physical Apple shares, but you will not own the underlying asset.

Transparent pricing

CFD prices are only driven by the movements of the underlying market. Our Apple CFD moves up in price as Apple’s share price increases, and down as it decreases. All other CFDs work in exactly the same way.

Option premiums, on the other hand, are driven by more than just the price of the underlying asset – they’ll also take the time to expiry and any underlying volatility into account.

No expiries

Unlike options, spot CFDs have no expiry dates – you can leave positions open for as long as you want. With options, your contracts can expire and become worthless.

As an option moves closer to expiry, its price will drop. This is a process known as time decay. So your positions may naturally diminish in value over time. With CFDs, time decay isn’t applicable.

Leverage

You only have to put down a percentage of the notional value of your CFD trade to open a position– known as margin. To make a trade on the FTSE 100 worth £5000, for example, you might only have to put down £250. So, you can free up your capital for other investments or trades. However, it’s important to note that while leverage can magnify your profits, it can also amplify your losses. Profits and losses are based on the full value of your trade, and not the margin value.

Choice of markets

You can use CFDs to trade a huge range of markets. When trading CFDs with us, for example, you get access to more than 17,000 assets across shares, indices, forex, commodities and more. Most options brokers will provide far fewer markets to trade.

It is important to ensure that you’re making informed decisions before taking any position.

Discover how you can manage your risk

With us, you can even use CFDs to speculate on option prices. Instead of giving you the right to buy or sell a market at a set price, option CFDs enable you to go long or short on the movements of option premiums. You can trade CFDs on daily, weekly, monthly and quarterly options.

CFD vs options trading: which is best?

Whether CFDs or options are better for you depends on what you're looking for as a trader.

Options (both CFD and US-listed)

• Limited risk when buying
• Advanced strategies available
• Useful for hedging
• Affected by time decay and volatility

CFDs

• Offer a wide range of markets
• Transparent pricing
• Leverage available

With us, you can trade US-listed options and futures, as well as CFDs, across a huge range of markets. Each offers unique advantages and risks. It's crucial to understand these differences and choose the product that best fits your trading strategy and risk tolerance.

Remember, all forms of trading carry risk, and you should never risk more than you can afford to lose. Always ensure you're making informed decisions before taking any position.

Open a live account to get started.