Why Franking Credits are Important in CFD Trading

A common question people ask is ‘do I receive dividends when buying CFDs?’ The answer to the question is simple, ‘yes’. However, there are a few things to be aware of as CFDs are a derivative contract between the CFD provider and the buyer or seller of the CFD. The holder of a CFD does not own the underlying equity over which the CFD is based as such the treatment of dividends is somewhat different to what most CFD traders could have become accustomed to when trading shares.

Unlike ordinary shares, the dividends received by the holder of a long CFD position don’t have any franking credits attached to them. A franking credit is a tax credit offered by the company with the dividend, when it is paid to shareholders. Essentially the company over which the CFD is derived has paid a portion of tax on behalf of its shareholders. Fully franked dividends have a 30% tax credit attached. The concept of franking credits is peculiar to Australian companies.

When buying stocks it’s important to understand that in order to be entitled to dividend franking credits it is obligatory to own the equities for 47 days which includes the dividend date. The formal requirement is 45 days but this does not consist of the days the equities are bought or sold which increases the holding period by an additional two days. Although franking credits are not attached to CFDs most CFD traders aren't concerned as most are not long-term buyers and don’t hold their CFD positions open long enough to gain any real benefit.

CFDs traders can sell a CFD just as easily as they can buy a CFD, selling a CFD without holding a long open position is known as short selling. It is important to note that there is an obligation to pay a dividend to the CFD provider when a short sold CFD position is held over the ex-date. The ex-date is the date on which the seller, and not the buyer, of a stock will be entitled to the dividend.

It’s important to understand that when paying the dividend on a short sold position you might also be liable to pay the franked component of the dividend. The main reason you might be liable to pay the franked component along with the declared dividend amount is because when your CFD provider hedges your short position in the market they were required to borrow stock from an owner of the shares, it is possible that they borrowed the stock to cover your short position from another Australian resident who is also entitled to the franking credits. Typically your CFD provider will make an effort to secure stock from overseas where the owners of the stock don't have any use for franking credits. You should always ask your CFD provider prior to short selling a CFD over dividend periods as you may find that you’re also liable to pay the franked component of the dividend.

There are a variety of trading strategies CFD traders can employ over dividend periods, one of these strategies is called dividend stripping. Dividend stripping is the purchase of stocks prior to a dividend being paid, and the sale of those stocks after that payment. Understanding dividends and ways to trade CFDs around dividend periods is important when developing your CFD trading strategy.

Article Source: http://www.newsarticlessite.com

Pradeep Rathsan is an experienced CFD trader. Pradeep began trading CFDs 10 years ago, initially in the UK and currently in Australia. Pradeep lectures aspiring traders around Australia. He has published a variety of ebooks and manuals on CFD trading

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