How are CFDs settled in Singapore?
Contracts for Difference (CFDs) are a popular choice among investors regarding online trading. But what exactly are CFDs, and how are they settled in Singapore?
A CFD is a contract between the buyer and the seller – where the buyer agrees to pay the seller the difference between the opening and closing price of an underlying asset. The asset can be anything from shares, commodities, currencies or even indices.
As CFDs are traded on margin, you only need to put down a small deposit – known as the margin – to open a position. You can trade with leverage and potentially make more enormous profits (or losses) than if you were to trade the underlying asset directly. However, CFDs are considered high-risk investments and unsuitable for everyone because of the leverage involved. Before trading CFDs, you should first understand the risks involved and ensure that you have the financial resources to cover your losses.
There are two main types of CFDs for settlement: physical settlement and cash settlement.
With a physical settlement, the underlying asset is exchanged between the buyer and seller at the end of the contract. If you buy a CFD on gold, you would need to take delivery of the actual gold bars or coins at the end of the contract.
On the other hand, no actual exchange of assets takes place with a cash settlement. Instead, the buyer and seller settle their obligations in cash, based on the difference between the opening and closing price of the underlying asset. In Singapore, the majority of CFDs are settled in cash. Most CFD providers do not offer physical settlements for CFDs on shares, currencies or indices.
However, there are some exceptions. For example, if you were to trade CFDs on agricultural commodities such as wheat or corn, you would need to take delivery of the actual commodity at the end of the contract. The same goes for CFDs on metals such as gold and silver.
Main advantages of cash settlement
The market is more liquid
The market for cash-settled CFDs is much more liquid than that for physically-settled CFDs. It is easier to buy and sell cash-settled CFDs at the price you want.
You can trade on margin
Because there is no need to put up the total value of the underlying asset, you can trade on margin with cash-settled CFDs, and potentially make bigger profits (or losses).
No need to take physical delivery
With a physical settlement, you have to take delivery of the underlying asset at the end of the contract. It can be a hassle, mainly if you are trading internationally. There is no need to take delivery with cash settlement as the contract is settled in cash.
Cash settlement is much more flexible than physical settlement. It is because you can choose to settle your contract before it expires. For example, if you want to take profits early, you can do so by selling your CFD before it expires.
You can avoid stamp duty
In some countries, you have to pay stamp duty on physical shares. However, this is not the case with cash-settled CFDs, as they are not classed as financial instruments. As such, you can avoid paying stamp duty on cash-settled CFDs.
Main advantages of physical settlements
Fewer concerns about prices falling
You don’t have to worry about the underlying asset’s price falling before the contract expires with a physical settlement. You already own the asset, so your profit is locked in.
You can avoid capital gains tax
In some countries, you have to pay capital gains tax on profits from cash-settled CFDs. However, this is not the case with physical-settled CFDs, as they are not classed as financial instruments. As such, you can avoid paying capital gains tax on physical-settled CFDs.
You can use the asset as collateral
You can use it as collateral for other investments because you own the underlying asset with a physical settlement. For example, you could use your gold to get a loan or secure a mortgage.