I'm curious as to how the Contracts For Difference (CFDs) work.

I understand how they work for the consumer side - you enter into an agreement to pay/be paid the difference between the stock price at time of entry and exit, but how does the broker achieve that and where do they get the money to pay you?

Do they buy the stock themselves and hold onto it, or is there something else going on?


There are several ways that the issuers profit from CFDs. If the broker has trades on both sides (buy and sell) they can net the volumes off against each other and profit off the spread whilst using the posted margins to cover p&l from both sides. Because settlement for most securities is not on the same day that the order is placed they can also buy the security with no intention of taking delivery and simply sell it off at the end of day to pass delivery on to someone else. Here again they profit from the spread and that their volumes give them really low commissions so their costs are much lower than the value of the spread. If they have to do this rather than netting the position out the spreads will be wider. Sometimes that may be forced to buy the security outright but that is rare and the spreads will be even wider so that they can make a decent profit.

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