Literature on hedging contract for difference (CFDs)

External question — Quantitative Finance Stack Exchange Author: Xerium Original post: https://quant.stackexchange.com/questions/78233 License: CC BY-SA 4.0 — https://creativecommons.org/licenses/by-sa/4.0/ Adaptation: HTML converted to plain text; contact email addresses removed. I’m looking for research specifically for CFD brokers wanting to hedge risk when a customer buys CFDs. Preferably research on using derivatives like options, futures etc to hedge the risk, instead of just simply buying the underlying with another market participant. I.e. a customer buys a CFD that is long AAPL, so CFD broker buys AAPL calls or sells puts to hedge the risk, NOT just replicating a % of client’s order with another market participant.

External answer — Quantitative Finance Stack Exchange Author: AlRacoon Original post: https://quant.stackexchange.com/a/78240 License: CC BY-SA 4.0 — https://creativecommons.org/licenses/by-sa/4.0/ Adaptation: HTML converted to plain text; contact email addresses removed. CFDs (Cash for differences) is a delta 1 product. This is a way for an investor to get synthetically long (short) the asset by buying (selling) the CFD. They participate in the appreciation (depreciation) of the asset without having to own it. The investor is able get long (short) the asset without putting it on their balance sheet. In effect, they are borrowing to get exposure to the asset. As a leveraged position, the investor will pay financing to the broker to put the position on their balance sheet. The interest can be fixed or floating (SOFR + spd). If a dealer is paying a customer the appreciation on the underlying, they will have to hedge themselves by sourcing the risk, as they are short the asset. In other words, get long exposure to the asset to hedge their short position via the CFD they sold to the customer. They are in effect putting the asset on their balance sheet, and will receive interest from financing the position on behalf of the client. To source the risk, they will have to purchase the asset at the strike of the CFD. Alternatively, they can get long exposure to the asset synthetically themselves (ie. buy CFD aka Total Return Swap, future, fwd, revcon (long call and short put at the same strike)). At the interim payment exchange dates, they would pay the client the appreciation or receive depreciation; and receive the interest payment. At the maturity or final payment exchange date, they would pay the client the appreciation or receive depreciation since the previous payment exchange date, receive the interest payment, and unwind their long position in the underlying.