Q: I’ve seen a lot of adverts on the television for CFD trading. A friend of mine has described CFD trading as “futures on steroids”. I’m fairly conservative but would like to lift the flagging balance in my SMSF. Is there any logic in my having a look at combining CFDs with my SMSF?

A: A CFD or Contract for difference is an agreement between 2 parties to access the movement in the price of shares, market indices, commodities, and currencies without owning the underlying investment. You share in the rise and fall of the value of the investment. Usually there are no restrictions to the upside or the downside fortunes of the contract.

The requirement to fund the exposure will vary depending on the contract entered into but could be as little as around 1% of the market value. The leverage affects of this can be enormous. For example. If you wanted exposure to $200,000 of Australian Shares, the margin cost to fund that exposure could be say $6,000. If the market rises great, but if the stocks fell 6%, you would have lost $12,000 or double your cost and you are liable for it!

CFD providers advertise that you can manage this risk by executing stop losses or auto sells at certain price points in the market. Everything is “fine” as long you can afford the loss and the CFD provider can fulfill their obligations….. As with all structured products, futures and derivatives, you run the risk of counter party risk. The collapse of MF Global has left investors with frozen accounts and uncertainty as to the status of pending trades. Perhaps the worst part of all is that open positions will be closed out by the administrators without the client having any discretion as to the timing or the price they accept.

CFD’s can be traded inside an SMSF provided the Trust Deed allows investments in CFD’s and the investment strategy of the fund permits the investment.

CFD’s are not for the faint hearted and have been heavily promoted in Australia., many would argue to an audience who should go nowhere near them. The “logic” of CFD’s? Mm, CFD’s have nothing to do with long term investing, traders are “punting” on the rise and fall in the value of the asset. “Futures on Steroids?” The consequences for a conservative investor of the market going the wrong way with a CFD trade; “Think Godzilla meets Bambi!”.

This article was published in The Australian on 5 November 2011. A direct link to the article can be found here.

If you have a question you would like Andrew to answer, you can go here and click on the “Your Questions” section.