Funding for Shares and Indices
This educational article will be focused on funding for shares and indices within the CFD and Spread Betting sector. CFD and Spread Betting are both leveraged products and therefore funding will be required for non-future contracts. FX funding also known as TOM-NEXT will be covered in a separate article by Financial Trading Explained.
When trading with leverage you are basically trading with loaned funds and as loans work you will have to pay interest on them. This is totally fine but you should always be able to calculate how high this interest is and therefore influence your trading decision. Think of interest payments as a cost of doing business, this cost should also be deducted from the overall profit you have made on a trade, to reflect the true profit rather than revenue.
Daily vs Forwards
I have written another article on this “Dailies vs Forwards - which are best?” which is interlinked with this topic of funding. In a nutshell dailies or open-ended contracts pay interest. Dated contracts, futures and products which expire, have funding included in the spread.
How Brokers Calculate Interest
Your broker will usually charge you interest on your positions at a daily rate. Please check your broker’s website to see which formula or figures they use. Secondly, it also depends how large your position is. The formula for interest payments will look something like this:
Daily funding = ((annual funding rate x consideration*) / 360 or 365)
Brokers will normally use:
- LIBOR / The London Interbank Offered Rate for GBP trades
- EURIBOR / The Euro Interbank Offered Ratefor EUR trades
- + 2.5%
*Consideration, notional value or the value of trade all mean the amount of money you are investing in the market or simply the amount of money needed without leverage.
Share funding example
We will use a random example to illustrate funding a shares position.
- Buying 10,000 shares of Barclays Bank , Barc.l
- Barclays currently at £2.24
- 1 month LIBOR = 0.25%
- Broker interest = 2.5%
- Consideration (CFD) = 10,000 shares x £2.24 = £22,400
Consideration (SB) = £100per point x 224 = £22,400
- £22,400 x (0.25% + 2.5%) = £616 annual interest
- 616 / 365 = £1.69 daily interest payment
Even though funding costs are currently very low, at around 2.75%, it is still good to understand how these are calculated and they should not be ignored, especially for long-term trades.
Index funding example
Funding an index position is very similar to funding a share position. When you want to calculate funding, first of all consider what currency your trade is in. If you Spread Bet in GBP on the German DAX30, would you use LIBOR or EURIBOR? The answer is LIBOR because essentially your loan is in GBP.
- DAX is currently at 11,200
- I am Spread Betting £5 per point
- Consideration is 11,200 x 5 = £56,000
- £56k x (2.5% + 0.25%) = £1540
- 1560 / 360 = £4.28 per funding per day
In this example I would like to focus on the amount paid per day. £4.28 might sound like a lot of money as a daily funding charge, but is it really, in relation to the trade? First of all remember that the trade is worth £56,000 and you only pay 2.75% interest, a level that you probably would not receive from your bank. Secondly one point of movement on the DAX, will cover your interest payment.
Funding on short positions
Funding on a short position will cost you, in a low interest environment, but can also generate funds in a high interest environment. If you are unsure about the topic of going short please read the following article “Going Short!”
When going short, you would use the exact same calculation for your consideration as we used in the examples above. The part of the formula I would like to focus on is LIBOR + the broker cost. When going short it will not be plus, but minus 2.5%.
- LIBOR – broker cost
- 25% -2.5% = -2.25 because this number is negative you will still be paying the broker but in comparison to the long position (2.75%) it will be less funding.
- Assuming LIBOR = 3% (when the Bank of England raises interest rates).
- 3% - 2.5% = 0.5% (now the number is positive on a short position).
- DAX consideration £56,000
- 56k x 0.5% = 280
- 280 /360 = £0.78 (the amount of money I would receive every day by just keeping the position open on the short DAX position).
Knowing how much you are paying for funding is just one more variable that you should keep an eye on when trading. Please use future or forward contracts when possible for long term trading as they are more cost effective.
Financial Trading Explained also wants to point out that consideration of trades, interest rates and broker rates can change on a daily basis and therefore, funding can only be estimated. In saying that, numbers normally only change a minimal amount and a ball park figure should be accurate enough to consider, if the position should be held for a longer period of time. £1.15 or £1.17 will probably not influence your decision, but £10 per day might do, as a daily cost. Know your funding cost per trade.
Explained by Stefano Ceacmacudis