CFDs vs Options: Differences, Similarities, and Which to Choose?

When it comes to trading, there are a variety of different options available. Two of the most popular trading vehicles are contracts for difference (CFDs) and options. 

Both have their own unique benefits and drawbacks. We will compare CFDs and options, and help you decide which one is the best fit for your trading needs.

CFDs vs Options: Which to Choose

A CFD is a good choice to trade if:

• You use a variety of trading styles based on market conditions
• You like the flexibility and nimbleness to get in and out of markets 
• You are interested in taking advantage of the pure price movement of the underlying financial asset (the underlying)
• You have no interest in owning the underlying asset

An option contract can be a good alternative if:

• You mostly swing trade
• Your trading strategy is good at timing the markets
• You are not only interested in trading for potential profits, you are also interested in owning the asset if the condition is right
• You are good at building options strategies to take advantage of a variety of market conditions

Similarities between CFDs and options

	CFD	Options
Is a derivative product	Yes	Yes
Use of leverage	Yes	Yes
Can have multiple types of underlyings	Yes	Yes

Both are Derivative Instruments

A CFD is a contract between a trader and the CFD provider that stipulates the amount to be paid when the contract is terminated. This amount is calculated by the difference between the entry and exit price of the underlying.^[1]

An option is a contract between a trader and the counterparty that gives the buyer the right to buy or sell (under a call or a put option, respectively).^[2]

Both Allow Leverage

Leverage for CFDs is given by the provider. Leverage in options is built into the product. 

Both Have Flexible Financial Derivatives

Both CFDs and options can have a variety of underlyings, including forex, shares and commodities, etc.

Differences between CFDs and Options

1. Trading style

CFDs work for any trading style like scalping, day-trading, or swing-trading, but options are typically well-suited for swing trading. When you trade CFDs, you are able to capitalise on the opening and closing price movements of the underlying asset without ownership.

Your account will be either credited or debited by the amount of your profit or loss, respectively. 

On the other hand, day-trading on options can be restrictive. This is due to:^[3]

• Price movement reductions – Price movement can be limited by the delta value as well as the time value element of your options premium. 

The delta value of an option is the ratio at which the price of the contract moves compared with the price of the underlying security. For example, the price of a contract with a delta value of 0.6 would move $0.60 for every $1.00 move in the price of the underlying security.

Additionally, the time value also impacts the option price movement. Even as the underlying instrument’s price increases, this gain could be undermined by the loss of time value, as an option’s price will decline over time.

• Wider bid-ask spreads – For a specific underlying instrument (say, stocks), options markets often have lower trading volumes compared with the equity markets for the same instruments. The lower trading volumes always result in wider spreads, and this can easily affect your account balance when you day trade.

2. Market Conditions

CFDs are best suited for trending markets. On the other hand, it is possible to take advantage of any market conditions (trending up, down, or sideways) by building suitable options strategies.^[4]

3. Possibility of Ownership

CFDs do not give you the possibility to own the underlying, but options do. You can exercise your rights under a call option to acquire the underlying asset.

4. How to Take Advantage of the Market

CFDs offer the possibility to take advantage of the price movement of the underlying, whereas options trading opportunities arise from intrinsic value (compare strike price versus current value of underlying) and time value (the expected volatility and time left until option’s expiration date.

5. Product Pricing

Pricing of CFDs is straightforward as prices are quoted in the same way as the underlying. However, options pricing considers both the theoretical prices using complex mathematical models as well as market forces. 

6. Transaction and Financing Costs

When trading CFDs, you incur transaction costs (fixed-ticket, bid-ask spread, or spread plus a small commission for direct market access, depending on your provider and your account type), as well as overnight swap fees. When trading options, you only pay the broker commissions. 

7. OTC v. Central Exchanges

CFDs are over-the-counter (OTC) products provided by your CFD provider, whereas some options are traded over the central exchanges (such as public company shares) and some are also OTC. 

Factors in Deciding Between CFD and Options

1. Your Trading Style

Are you a scalper, day-trader, or swing trader? Do you predominately stick to one style, or do you sometimes vary how long you keep your positions based on your market outlook? 

This is important because CFDs can give you the highest degree of flexibility for your trading style. Contrast that with the scenario where you have an option position. Closing an option position before its expiry date can sometimes lead to potentially lower returns than holding the position to expiration under ideal market conditions.

2. Market Conditions

Since the trading returns from CFDs are calculated by the difference between entry and exit prices, you would want the expected key differences between these two prices to be significantly larger than your trade risk before you enter a trade. The amount of time it takes to accomplish the price movement does not matter for CFD trading.

The same cannot be said about options trading, owing to the fact that options contracts always come with a finite time frame, your trading strategies need to not only determine the direction of the price movement, but also the amount of time it takes to get there.

This means that CFD trading is typically performed when the market is trending, whereas you can still take advantage from range-bound market conditions with options trading through different option combination strategies.

3. Trading Opportunities and Potential

Whenever there is a movement in the underlying asset’s price, there is a trading potential for CFD trading.

Options trading, however, is more complicated.

Trading options require you to build an option combination. Each combination is an options strategy that is premised upon your thesis of the market condition and your prediction of where the market is going. Because of that, you are able to build a large number of options strategies to profit from the financial markets.

Conclusion

When deciding between CFD trading and options trading, it’s crucial to consider the key advantages and differences of each financial derivative. CFD trades enable you to capitalise on the market value movements without owning the underlying asset, while options trading provides the potential to profit from predetermined price and fixed price through advanced trading strategies.

In conclusion, for short-term investors who are not interested in the long-term holding of an asset, using a CFD can potentially be an effective way to take advantage of price movements. By using leverage, investors can increase their trading opportunities while also their losses too. If you have a sound trading strategy and are looking to take advantage of market timing, options may be a choice for you to consider.

References