Derivatives have been traded worldwide since ancient times. In the 18th
century, there was a major breakthrough in Japan, with the establishment of the first secondary market for commodity derivatives. Transferable rice vouchers were commonly traded, which could be settled for cash. It had a clearing house, like we do today, to settle the contracts. The Dojima rice exchange is considered the first derivative market of the modern world.
This new form of trading finally reached America and the Chicago Board of Trade was founded in 1848. In 1865, such trading was more standardised and regulations were introduced to increase efficiency and reduce transaction costs. In the 20th
century, the Chicago Board started trading in a variety of derivatives, ranging from metals to agricultural commodities.
A warrant is like an option. It gives the trader the right, but not the obligation, to buy an underlying asset at a pre-determined price, future time and quantity of that asset. A warrant is issued by a company and the security is delivered by the issuing company instead of the investor holding a share. Companies often include warrants as part of new offerings to attract investors to buy the new security. A warrant can also increase shareholder trust in a stock, if the value of the underlying asset increases over time.
There are two types of warrants:
- Call Warrant, which involves trading shares that can be purchased at a specific price, on or before a certain date from the issuer.
- Put Warrant, which involves trading shares that can be sold at a specific price, on or before a certain date back to the issuer.
A CFD is an agreement to exchange the difference in the prices of an asset at the beginning of a contract and its end. CFDs transactions are based on fluctuations in prices of an underlying asset where the trader speculates on price movements. If they believe that the price will increase, they would buy or take a long position and if they believe that the price will fall, they would agree to sell or take a short position in the market.
Differences between CFDs and Warrants
The Fundamental Concept
A warrant gives the trader the right but not the obligation to buy an underlying asset at a certain price, future time and quantity of that asset. On the other hand, a contract for difference is an agreement between a trader and a CFD provider where the outcome is based on the price of an underlying asset between the time that you enter the trade and the time that you exit it. With CFDs, you will never own the underlying asset, while with warrants, you might have the opportunity to buy the asset itself.
CFDs providers are regulated brokers by Competent Authorities. In Europe, regulations have become stricter over the last years giving significant importance to protection of retail clients. However, a profound investigation of the CFDs provider would benefit you before entering in a transaction with them.
Like any other type of investment, warrants have their drawbacks and risks. The leverage and gearing warrants offer can be high which can work to the disadvantage of the investor. Another risk associated with warrants is that the value of the certificate can drop to zero. If that were to happen before it is exercised, the warrant would lose any redemption value. On the other hand, CFDs are risky since you are trading on leverage therefore you could lose more than your initial investment. Other risks associated with CFDs include execution, gapping risks and counterparty risks. You should thoroughly study CFD trading before choosing to trade.
Similarities between CFDs and Warrants
For example, in traditional trading, if you invest in a company share, you get ownership of shares of the company however in CFDs and warrants you will invest on an underlying asset. Since warrants and CFDs brokers may offer leverage to its clients, you may be able to choose whether to trade with leverage or not. When trading with leverage the margin required to enter in a transaction may be only a percentage of the total value of the transaction.
If the price of the underlying asset rises you will make a gain which will provide a positive return on your CFD available margin. However, if the price of the underlying asset falls, you will end up having a negative impact in your balance and therefore in your investment.
Trading in CFDs and warrants requires much deeper knowledge and understanding of the market. They require a deeper management and attention because of the leverage and the fact you are always competing in this market. If you make profits on a trade, the other party loses. The high risk associated also demands all-round analysis and observation of the price movement of the underlying assets.
Since CFDs and warrants are derivative products that don’t involve ownership of the actual physical asset, they are exempt from stamp duty as per the current tax laws in the UK. But profits on both CFDs and warrants are subject to capital gains tax.
In CFDs and warrants, trading commissions are considerably low compared to other investment products which it varies among different providers, therefore you should ensure being fully aware of these charges and fees.
With the introduction of computers in the financial market and the advantage of the internet, derivatives trading has touched new peaks. CFD providers began offering a full range of financial instruments, including less popular such as uranium and agricultural commodities. Both derivative instruments are for active traders, who want to be consistently engaged with their investments.