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How Broker Contracts and Arbitrage Keep CFDs Near Their Underlying

Article Quant Q&A · Author: dan
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Summary

The document explains why a contract for difference (CFD) tends to track its underlying asset. A CFD is a contract with a provider, so its value depends on the terms and creditworthiness of that provider; the holder does not own the underlying asset and may face loss if the provider defaults.

The second explanation focuses on the provider's role as the counterparty: it offers to buy or sell the CFD at a value tied to the underlying. If the CFD price diverges from that value, a trader may have an incentive to buy the cheaper exposure or sell the more expensive one, creating pressure toward alignment. This gives an intuitive arbitrage explanation, but the document does not detail contract terms, fees, execution limits, or how reliably a provider maintains that pricing. Its explanation should therefore be read as a simplified account of a broker-mediated market, with counterparty risk remaining material.

Key ideas

  • A CFD is a contractual claim against its provider rather than ownership of the underlying asset.
  • The provider's buyback and sale terms can link CFD prices to the underlying price.
  • Price divergence can create arbitrage incentives that push the two values together.
  • Provider default can prevent a winning CFD holder from realizing the expected value.

Tags

Derivatives pricingArbitrageRisk management
Full text
# Why do CFDs track the underlying?


# Why do CFDs track the underlying?












My understanding of CFDs is that the profit you make on a CFD is the difference between the price at which you bought the CFD and the price at which you sold your CFD minus various charges/commission.

The idea being that the CFD tracks the underlying and therefore you can speculate on the price of the underlying.

My question is, why does the CFD track the underlying? There is nothing about the CFD that forces it to follow it is there? Or is there?

Edit: To clarify the question... The CFD is priced according to supply and demand The underlying is priced according to supply and demand These two are priced independently. Isn't it possible that they move completely independently of each other?

## Answer by SRKX (score 2)

https://quant.stackexchange.com/a/21114

I might be wording this answer incorrectly so if some law expert wants to correct anything, please feel free.

It is my understanding that CFD are contracts you pass with your CFD broker. So, this contract has a value as long as your broker exists and hasn't decided not to pay you. So, in a sense, the price is just set by the agreement between you and him.

Say the broker defaults, you won't have any claim on the underlying, and you won't be able to get anything out of you're winning positions (except, of course, claiming you're owed your gains if the broker goes into liquidation and waiting to see if you get something after all legal procedures are over... i.e you won't get anything).

## Answer by Tom Sun (score 0)

https://quant.stackexchange.com/a/21132

When you enter a position with CFD, you're buying it from the CFD provider. And you can only sell it back to the CFD provider for the value of the underlying. So if AAPL is trading at \$100, you can only sell the CFD back to broker for \$100. If you're a CFD buyer, why would you buy the contract for more than \$100. If you're a CFD seller, why would you sell it for less than \$100? If the price of CFD is different from the price of underlying, there's arbitrage opportunity.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.