With CFD Prices and Trading Costs models, most investors favour the DMA (Direct Market Access) procedure. Demand for Direct Market Access CFDs has caused an increasing number of brokers to offer them. What caused this move towards DMA and away from synthetic pricing is the expanding amount of CFD investors, creating fierce competition amongst CFD brokers.
It has long been the case that brokers fill orders for actual shares at domestic stocks exchanges, such as the FTSE 100 or the ASX, with efficiency and price diffusion coming from the electronic matching procedure. With the growth towards CFD orders from smaller investors, the brokers created a way to be able to offer the real market prices on these orders.
The implications are that there is no separation between the prices of CFDs and the underlying assets. This provides many benefits, which is proven by the number of clients seen by brokers offering such pricing. Again, the key point here is that there is flawless matching between the market and CFD prices. Therefore, investors can take positions according to the present bid-ask quotes, and it remains the case that they are not dealing with the actual ownership of shares.
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Looking deeper, this has an impact seen in the concept of Delta (Δ), which should be recognized by those with a history in option trading. The concept of Delta refers to the percent change seen in a derivative product as it compares to the percent change in the actual security.
It is not as complicated as it seems to be. Using an example company for explanation, each time ABC limited shares increase 1 cent, there is also a 1 cent increase in the ABC limited DMA CFD. In other words, Δ is 1 here, or can be said to be perfect. On the other hand, in a synthetic pricing situation, there is no contractual requirement to keep the spreads of the CFD in line with those of the underlying asset. In other words, you can say that these market makers are not held to maintain a perfect Δ of one.
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Variations might be seen in situations where an increase of 4 cents in the share price would only be mirrored by a 3 cent increase in the spread’s bid price. You will see this when working with CFDs that have been priced synthetically, and it demonstrates how there is leeway for market makers to nudge CFD spreads wider in order to boost their profits and balance their internal positions. What you see as a result for investors like you and me is extra distance between where you planned to enter a position and where you end up entering.
So you might think selecting a synthetic pricing provider over a DMA provider would never make sense! The truth is that there is more to it than this issue alone. In response to competition from DMA pricing, synthetic brokers have stepped up their game by bettering their Δ and pricing overall. Due to the fact that synthetically priced CFD brokers are more entrenched in the industry and serve a larger base, it has led to a change in liquidity, impacting how brokers protect their exposure to CFD positions.
