A Guide to Contractslor Dlfforoncos

Contracts for Differences (CFDs) are a form of financial derivative that have become so popular that analysts have suggested up to 25% of the UK stock market turnover is attributable to them.Once the preserve of the City institu tions and professional investors such as hedge funds,this powerful trading tool is today also widely used by the private investor.

In CFD dealing, you do not physically buy or hold the physi cal underlying shares, rather you have agreement with a broker to exchange, at the closing of the contract, the difference between the opening and closing prices, multiplied by the number ofshares in the contract. If you think the price will rise you take a "long" position. If you thin k the price will fall you take a"short" position(selling stock you don't own then buying it back 'later, hopefully at a lower price to realise a profit).

So what are the advantages over traditional share dealing and how can they be used to enhance port folio returns?

i No Stamp Duty. The 0.5';"- stamp duty payable on UK equity purchas es does not apply to CFD trading.

ii Going short.CFDs offer investors the possibility ofgoing short,thereby being able to profit from falling as well as rising markets.

iii Margin.CFDs are dealt on a mar gin basis. For most shares a deposit of 10% (known as "initial margin") is required. For example, if you wanted to purchase 10,000 shares of Vodafone at 120p, you would need just £1,200 to place the trade, rather than the full £12,000. Positions are automatically rolled over each day and marked to market so further margin (known as "variation mar gin") may be required depending upon the performance of the under lying share. iv Gearing. This idea of margin allows investors to leverage their positions significantly. For example a 10% rise in Vodafone to 132p on the above position would result in a profit of £1,200(excl. commission and financing costs) on a capital outlay of just £1,200. This gearing however works both ways and a fall of 10% to 108p will result in a loss of £1,200 thereby wiping out your entire capital.

V Costs. With no settlement costs, CFD brokers are able to charge around 0.25% for opening and closing positions. Also, as you are effectively using the brokers money on the £10,800 not required, long positions attract a financing charge, generally LIBOR + 3%.

Trading Strategies

Low commission,leveraged trad ing and zero stamp duty all make CFDs attractive for investors hop ing to benefit from predominantly short-term price movements.CFDs are not a substitute to traditional share dealing but can complement an investment portfolio by using the following strategies: i Hedging. Investors can use CFDs to hedge against price falls in exist ing shareholdings by taking out a short CFD.1f the share price falls, the investor loses money on the underly ing shares but gains on the CFD. ii Index/Sector Reviews. As com panies are promoted to/demoted from the FTSE 100 index during its quarterly review, tracking funds are forced to buy/sell the affected shares. CFD traders can take ad vantage of this by going long/short of these shares. Other opportunities

V Pairs Trading. Pairs trading involves identifying two similar shares-usually from the same sector-with prices that generally move in tandem but that have temporarily diverged. The idea is then to exploit the anticipated convergence ofthese prices by buying the laggard and short-selling the leader so that any narrowing of the price differential would result in a profit. Examples include BP/Royal Dutch Shell. The beauty of pairs trading is that it doesn't matter whether the market rises or falls, since the outcome of the trade simply relies on the relative movement of the two shares, vi Stripping the Dividend. If you own an equity CFD on the day the share goes ex-dividend (the day the shares no longer trade with the right to the next dividend payment), you will be credited with the net dividend. Theoretically the share price will fall on the XD date by the same amount of the dividend. But a stock with good momentum behind it may not fall by the whole amount. A trader who buys a share paying a large divided the day before and closes the position on the XD date may be able to book a small profit.

In summary, CFDs are an excel lent vehicle for short-term trading strategies.Asa leveraged,margined instrument the risks are inherently higher than traditional share deal ing as you may lose more than the original sum invested. Investors should therefore seek professional advice prior to dealing and incor porate stop losses and other risk management techniques into their investment strategy.

Mark Mahtiey is a Director of Gibraltar Asset Management Limited, 1 Irish Place. Tel: 75181

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Michael Sero Clbraltar