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Over the past year or so, a couple of brokers in the UK have introduced no leverage CFDs.
I always thought a long spread bet that has no leverage would be a good product, as you could have anyone that maxed out their ISA allowance use them and then clip off quite a good whack of that amount, so long as it was below the capital gains tax that the investor would otherwise pay.
But zero leverage CFDs have coincided with the UK’s ‘Consumer Duty’ rules coming into play. This is the latest overkill piece of legislation put in place by the FCA, who seem to be edging closer towards the logic that the only acceptable financial product to offer retail is an ETF or having cash in the bank.
Whatever the case, that the emergence of no leverage CFDs has coincided with those rules coming into play, suggests firms have been looking to dump clients, for whom leveraged products aren’t ‘suitable’, into them. The idea is probably that if you can get them to use 1x products for a while, they can then move into leveraged products down the line.
One interesting consequence of this may be that it reduces the headline client loss figure that brokers are required to put on their website. For example, eToro’s current loss stat is 51%, which is strikingly low and markedly different from the past. eToro is one of the brokers that offers no leverage CFDs.
The question you could then ask is, does this matter for onboarding clients? Some sites do pick up the fact that you have lower client losses than others and it seems plausible clients may look at the loss figure and find it a good reason to sign up.
On the other hand, I was a smoker for about 13 years and it may shock you to know that I did not suddenly quit because I finally decided to read the risk warning on my pack of duty free Camel Blues.
How do you hedge a synthetic index?
Followers of the renowned TradeInformer WhatsApp Channel will have seen the claim that, like Busquets in his prime, if you watch the whole CFD industry, you won’t see BITA, but if you see BITA, you’ll see the whole CFD industry.
BITA is a company that creates synthetic indices for firms. Last week it announced that XM had partnered with the company, allowing the broker’s clients to trade six different indices.
Of course, trading an index is almost an oxymoron. You can’t trade an index, only a derivative of it.
For CFD providers, this tends to mean that, somewhere down the line, someone is going to have to hedge in the underlying futures market.
But for a made up index, no such futures market exists – so how do you actually hedge that exposure?
A similar question comes to mind when looking at the indices offered by Deriv. The broker offers a range of what it calls ‘synthetic indices’.
Unlike BITA’s indices, these are not derived from a real market. Deriv says the following…
“The generation of our synthetic indices involves first generating a random number and then using that random number to produce a market quote. Our random number generator follows a cryptographically secure methodology to generate random numbers from a uniform distribution. Each index is named according to the percentage of volatility, which is fixed for that index (e.g. the Volatility 250 (1s) Index generates a fixed volatility of 250%).”
…but for real, does this mean that there is a 68% chance that over a one day (one month, one year?) period this index is going to move up or down by 250%? I have no idea. Someone who is better at maths than I am can try to explain it to me.
Either way, what is interesting about this product is that it has effectively created synthetic volatility. You know, that thing everyone wishes there was more of at the moment?
But then on the downside, if this is just a random number generator that creates volatility, and you don’t control that generator, how do you hedge that risk?
