Lesson 2 of 6
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Overnight funding (7)

Phillip Konchar

 

Overnight funding

When trading on margin you are effectively borrowing money to fund your position – for a refresh on what margin trading is please have a look at our Margin Trading Demystified course. Overnight funding is a fee charged by brokers to provide this leverage and to roll the trade. It is applied ‘overnight’, normally at 10pm on daily funded bets and cash CFD positions, the funding is charged on the notional trade size.

Calculating funding costs

Let’s run you through an example using the UK 100 – Rolling Cash trade placed in the previous lesson.

First, we work out the notional position of the trade: £10 stake multiplied by the price of 7485.9 = Notional Value of £74,859.

The funding charge on a long daily funded trade is the broker’s charge (2.5%) plus LIBOR (0.25%):

£74,859 x 2.75% = £2,058.62/365 (days in a year) = £5.64 daily charge.

The funding charge on a short daily funded trade is the broker’s charge (2.5%) minus LIBOR (0.25%): 

£74,859 x 2.25% = £1,684.33/365 = £4.61 daily charge.

Traders are charged three days overnight financing at weekends (Friday night, Saturday night and Sunday night).

Currency funding

Currencies differ when it comes to overnight funding because a trader is always long one currency and short the other.  The trader pays the LIBOR rate in the currency they are long and receives the LIBOR rate on the currency they are short, netted off this rate is called the ‘tomorrow next’ rate. The broker then adds their charge to the tom next rate to get the annualised overnight funding charge.

How to manage overnight funding charges

First, you need to be aware that holding margined positions (in spot markets) overnight will cost money. Factor this into your chosen trading style.

Because interest rates are so low at the moment brokers tend not to compete too much when it comes to the interest rate charged on overnight funding – so shopping around might not yield too much value. This doesn’t mean you shouldn’t know what it is you are being charged – if you trade a lot it doesn’t hurt calling up your broker and asking if they can offer you a better rate on overnight funding.

Traders can not manage the funding charge by closing and reopening positions just before and just after the cut off – normally 10pm – what is saved in the funding charge is normally given back in spread.

The key method of managing funding charges is to know the expected duration of your trade. If you typically hold your trades open for more than a week or two then investigate trading the futures price instead of the cash market. Futures markets do not incur overnight funding charges because the cost to hold them is already factored into the bid-offer spread (which is normally wider than the cash market). At some point over the duration of your trade, the total spread paid to trade a future might be less than the combined daily funding charges plus the tighter spread on the daily cash market. In short, be savvy and work out the total lifetime cost of the trade – that is what you are seeking to minimise.

Key Learning Points
  • Overnight funding is a fee charged by brokers to fund and roll daily funded bets or cash CFD positions overnight.
  • Funding is charged on the notional trade size.
  • Funding is only charged on open positions overnight, typically at 10pm.
  • Trades on the futures price include the funding cost in the spread quoted.
  • It is hard to actively manage this cost, but if you hold trades for more than a week or two you should investigate trading the futures market and comparing the total cost to that of trading the cash market.

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