Friday, 12 June 2009

Using CFDs to add gearing to our SMSF fund

So far we have invested our SMSF in the Vanguard Highgrowth fund, whose asset allocation is mostly the Australian and International share markets. Despite the recent poor performance of stock markets around the world, I'm still of the opinion that, in the medium- to long-term, this asset allocation is most likely to provide the best return for the amount of risk we are comfortable with. In fact, given that the Australian stock market appears to have possibly bottomed out in March, we have opened a CFD trading account with Commsec for our SMSF. I intend to buy a single ASX-200 index CFD (IQ) to add a modest amount (around 10%) leverage to our SMSF stock market investment. The margin on the index CFDs is 10% and each IQ CFD has a contract value of 10x the index. So, if the index is 4,000 the CFD contract value will be $40,000 and the initial margin required to buy 1 IQ CFD will be $4,000. Basically, the cost of the IQ CFD is the index value expressed in AUD, and every point movement in the index corresponds to a $10 gain or loss. So, if the ASX-200 index goes up 5% you will make 50% profit on your initial CFD purchase, and if it drops 5% you would lose 50% of the amount invested. We have transferred $5,000 from our SMSF bank account into the CFD trading account, and will buy one IQ CFD. The extra $1,000 would only be enough to cover margin calls if the index drops less than 2.5% from the level at which we buy in, so we'll have to keep a few thousand dollars in the SMSF cash account to cover potential margin calls.

When I initially applied to open an ASX CFD trading account, the index had climbed from below 3,500 to around 3,800. Unfortunately the first lot of paperwork from eSuperfund (our SMSF administrator) was incorrectly filled in for Comsec share CFD trading, not the ASX CFDs (which include index CFDs). In the few weeks it has taken for the correct paperwork to be completed and processed the market has risen to 4,070. It would have been nice to have bought the IQ CFD at 3,800 as we would now be sitting on a $2,700 unrealised profit to act as a buffer in case the market pulls back. As it is, I'm hoping we get an opportunity to buy in when the market has another bad day.

The brokerage costs for trading ASX index CFDs appear to be relatively modest, and the holding costs appear to be around 1.5% pa above the overnight cash rate. I'll find out exactly what the total cost is after we've bought a CFD and held the position open for a year.

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Gerard said...

Why wouldn't you use a call option instead of a CFD to protect your downside? said...

We're planning to add leverage (increased risk) to our SMSF investment rather than trying to protect it from downside. So we're going to buy an index CFD (which incorporates 10:1 leverage). SMSFs aren't generally allowed to borrow to invest, so this is one of the few ways to use gearing within a SMSF (the other common one would be to buy a leveraged managed fund, such as the Colonial First State Geared share fund - but the fees for such managed funds are relatively high).

If we wanted to reduce downside risk, the capital gains tax rates are quite low within superannuation accounts, so we could simply sell out of equity-linked investments and move some of our account balance into cash.

If we expected further downside in the stock market, and wanted to profit from that, we could buy PUT options (or warrants), or else we could sell index CFDs - although I'm not sure that the ASX listed CFDs can be short-sold (especially by a SMSF).

cfd trader said...

CFDs are probly one of the best investment options available to retail investors in some Europena countries and Australia as they are leveraged products, but besides that you can also shorten stock, indices and more.
As you mentioned with low interest rates it makes sense to hold medium to long term positions whereas when interest rates are high you can sell and get paid interest at the same time. Just before the recession we tried it and brings about 4% but you have to exit at the right time.