Using Short CFD Positions to hedge your portfolio

Part of the market cycle involves stock prices moving both up and down. Investors who hold profitable share portfolios can be faced with the dilemma of when to realise their profits. Often an investor will hold a positive long-term view on a share in their portfolio but may think that in the short term the share price will remain flat or even fall. Additionally an investor may not want to sell as it may trigger a capital gains tax liability.

CFDs are a simple and cost effective way for investors to protect a share position against a downward movement in the share price.

How it works

A short position profits when the stock price moves down and a long position profits when a stock price moves up. If you hold a long share position, one way to protect your profits without selling the share is to open a corresponding short CFD position. If an investor has an equal quantity of long and short positions in the same stock it doesn't matter what the stock price does - no profit or loss will be generated. The investor is said to be “hedged” against future movements in the share price.

The following chart illustrates how a short position profits whilst the share price falls.
 

Benefits of using CFDs to hedge

Short CFD positions earn interest

Interest is received by the holder of a short CFD position. This means you can earn additional income over the time that you hedge is in place.

CFDs have no expiry date

As CFDs have no expiry you are not committed to hedge for a fixed term. You can hedge a share position for any duration of you choice.

CFDs have no parcel size or strike price

CFDs do not require a fixed quantity or parcel. You can open a contract for any quantity which enables you to exactly match the CFD quantity with the number of shares you are holding.

Integration with MQ Prime

Prime is seamlessly integrated with MQ CFDs so that you have the ability to use CFDs to hedge share positions:

• Without the need for additional collateral
• With profits and losses settling into the same Cash Account in real time

Case Study

You should note that this example is illustrative only. It is not a recommendation to make any investment in any share, and should not be taken as personal advice. With a MQ Prime Facility, you are responsible for selecting the share for any position you take out. As such, the performance of any share position will depend mainly on your own investment decisions.

Ralph has been holding a 3,200 WBC share position for nine months. Over this time the WBC share price has appreciated $1.75 from Ralph's purchase price of $25.00. With the price of WBC hovering at all time highs around $26.75, Ralph is cautious about the short-term direction of WBC as they are due to release a profit update in coming weeks. Ralph is keen to lock in his profits but does not want to sell his WBC and crystalise a capital gain.

Rather than selling his WBC shares, Ralph opens a short CFD contract over 3,200 WBC.

Two weeks later the WBC share price falls by $2.00 in a single trading session after the release of a profit downgrade. This price fall will have no overall effect on Ralphs exposure to WBC as any losses on his WBC shares will be offset by profits on his short WBC CFD.

The following table illustrates how Ralph's share losses are completely offset by profits from his opposing CFD position.

Another five months have passed and the WBC share price has recovered back to $26.75. Ralph now wants to sell his shares.
Ralph closes his CFD hedge and sells his share positions. As he has held the WBC shares for more than 12 months Ralph may be entitled to a 50% discount on his capital gains tax.

If Ralph's view on the long-term direction of WBC was positive he could have closed his CFD hedge and continued to hold his WBC shares. This would enable him to participate in any future share price gains in WBC.