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Extended Settlement Contracts – What Are They?
Education | 01 June 2010
By: jason.liew
Articles (66) Profile

Oftentimes, readers may see DBS shares under the “Top 15 gainers” in Channel NewsAsia. However, sometimes, the symbol may look different with a suffix of “.ES”. Other shares such as OCBC, UOB, Olam etc. also have these suffix. Have you ever wondered what does this suffix “.ES” mean?

ES means “extended settlement”. As the name implies, the settlement period is extended, typically about 38 days, longer than that of a normal security investment. This also means that for investors who want to short the market, they have more than a month to settle the trades, instead of doing intra day selling.

Interested in them? Do read on.

More about ES contracts

An ES is a contract between two parties, to buy or sell a fixed quantity of underlying asset, at a specific time at a pre-determined price. Do you find this definition familiar? Yes, it is akin to a futures contract.

Similar to futures, the investor who has an open position in the ES (regardless of whether he is long or short), is not required to hold the position to maturity (or expiration). He can choose to close his open position through an offsetting trade in the same ES contract. If he chooses to hold to maturity, he has to settle the contract by physical delivery, as opposed to being cash settled.

SGX launched the first ES contracts on 20 Feb 09. At that time, there was much hoo-ha, as there were reports in the newspapers that some dealers were caught cheating in the examinations designed to ensure that dealers and remisiers are qualified to sell or advise in the use of ES contracts.

Before we elaborate on the advantages and disadvantages of ES contracts, let’s understand the terminology used in ES contracts. This is tabulated in Table 1 for ease of reference.

Explanation of terminology used in ES contracts
Table 1: Explanation of terminology used in ES contracts

Advantages of ES

I will elaborate on those advantages which pertain to retail investors. There are other advantages such as arbitraging and doing unique investment strategies such as calendar spreads which are not cost effective for retail investors and will not be discussed here.

Leverage

ES usually provides between 5x and 20x leverage. Thus, investors would be able to maximise their capital effectively. It is possible to reap high returns on equity with a small capital. Nevertheless, this is a double edged sword and cuts both ways.

An avenue for hedging

ES can also be used to hedge your positions. For example, if I have a long term positive view on SIA shares but I believe it is likely to slide in the next month, I may engage in ES contracts to protect myself against adverse short term downward movement in the share price.

Disadvantages of ES

Physical settlement
Upon expiry, if the investor does not have the required shares in his account to do physical delivery, there will be a buy-in to fulfil the delivery obligation. This would increase the investor’s transactional costs.

Overtrading

Some investors may have a tendency to overtrade as they only pay attention to the margin required for the trades. They may fail to take into account the full contract value. It will be too late to react when the positions move unfavorably and these investors face a margin call.

Margin calls

You will experience a margin call when the required margin is more than the equity in your account. This is best illustrated with Table 2 below. On Day 1, Trader A deposited S$1,680 in his account and bought 1,000 shares of DBS.ES.1006 at S$14.00. It closed at S$13.00 at end of Day 1.

We also assume the following:

1Maintenance margin = 10% of the ES contract

1Initial margin = 2% + Maintenance Margin

1 These margins are arbitrary. Readers are advised to check with their respective brokers on the specific rates.

Illustration of margin call at end of day 1
Table 2: Illustration of margin call at end of day 1

With reference to Table 2 above, Trader A has to top up S$880 within 2 market days.

Different treatments for different brokerage firms

Different brokerage firms have different types of implementation rules on ES. There are some brokerage firms which require a CDP sub account to be opened before ES contract can be contracted whereas others do not have such requirement. Furthermore, some brokerage firms allow ES contracts to be traded online whereas others can only be executed via broker.

Illiquidity

Notwithstanding the above disadvantages of ES contracts, the most significant disadvantage of ES contracts lies in their illiquidity. Out of the 260 ES contracts traded on the SGX, only eight ES contracts were traded on 27 May 10 (refer to Table 3). None of the eight ES contracts has more than 10 lots traded.

ES contracts traded on 27 May 10
Table 3: ES contracts traded on 27 May 10

Conclusion – illiquidity kills ES contracts

With the apparent lack of liquidity, it is difficult to realise any of the advantages (i.e. hedging, shorting and leverage) outlined above. In my opinion, Contract for Difference (refer to my article for more details<< Thinking Of Shorting The Market? Consider CFD – 26 May 10>>) is a better instrument than ES contract to realise the aforementioned advantages.


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The Shares Investment editorial team welcomes constructive feedback on our coverage and content. We would also be delighted to answer any questions on the above article. Leave us a comment below, and we'll get back to you shortly!

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