Yahoo7 Finance

Case study

Jim bought 5000 AMP shares in 2004 and has since seen the value of his investment more than double. He believes the financial services sector will continue to be a growth area, earning him a good return from his shareholding over the medium term. However he expects the overall market may fall in the short term especially given current problems in the US banking system. Rather than sell his shares he decides to hedge using AMP share CFDs to protect their value.

On 10 July 2007, AMP shares break below support levels and Jim decides to sell 5000 AMP share CFDs to hedge his physical share position.

By 15 August 2007, AMP’s share price has declined to $9.72. This represents a decline of 6.72% since 10 July and the value of Jim’s 5000 shares investment has declined by $3500 from $52,100 to $48,600.

However, this loss in value is offset by a gain of $3,613 on Jim's AMP share CFD hedge trade as shown below.

Risk

If the share market had risen, although Jim’s underlying share investment would have gone up, he would have incurred a loss on his short AMP share CFD position.

It is important to note that losses on the CFD position have to be covered by cash, while profits on the share portfolio will be paper gains only. Therefore sufficient cash is required to cover the CFD margin at all times.

Advantages of Hedging with CFD's

The flexibility provided by CFD hedging strategies gives investors the opportunity to improve returns over time. It can be used to protect existing investments when market values become overstretched, or when external influences cause sharp breaks to the downside. This can be done:

* Without selling your shares and incuring a CGT liability
* Without changing the overall balance of your share portfolio
* Quickly & efficiently
* With relatively small transaction costs

Summary:

Hedging is a strategy designed to minimise risks. For most investors with a portfolio of shares and CFDs this means the risk of falling prices. CFDs provide a cost effective means of locking in prices for as little or as long as is needed.

More about CMC Markets CMC Markets is a pioneer of CFD trading in Australia. Our goal is to empower Australian traders by giving you access to CFDs over Australian and global markets and the ability to trade on leverage and potentially profit in almost any market condition. We run regular CFD introduction seminars and education courses around Australia for traders new to CFDs and are committed to providing a cost effective CFD trading service. Click here for more info or to start trading CFD's.