Extended settlement gives investors more flexibility in making short and long trades
By Lorna Tan 15 February 2009
Many retail investors have been stunned by the wild price swings seen in the stock market in the wake of the financial crisis and resulting economic gloom.
In such volatile conditions, it is no wonder that investors brave enough to stay in the market are finding it a challenge to pick stocks with a decent chance of gaining.
It is tempting to want to short- sell a specific stock, particularly when you hold a bearish view of its prospects and believe that there would be a substantial downside in its price.
Why would investors want to short-sell, and just what is this anyway?
In short-selling, a trader sells a stock he does not own in the hope of a price fall. If all goes well, when he later buys at a price lower than his selling price - in order to deliver on the sale - he is able to pocket the difference.
However, current rules require the short-seller to deliver his shares by buying them in the market by the end of the trading day, failing which he is slapped with an initial fine of $1,000 or 5 per cent of the trade (whichever is higher) for each failed delivery of securities.
Another way to avoid the penalty is to borrow the shares.
With this in mind, investors with hardy nerves for investing in rocky times may want to check out a new investing tool that offers more flexibility for both short and long trades.
On Friday, the Singapore Exchange (SGX) will be launching extended settlement (ES) contracts, which are also known as forward contracts.
The new product allows investors to buy or short-sell any of 28 securities listed on the SGX at the transacted price on the day of the trade for settlement at a specified future date.
Each ES contract is for 35 days or thereabouts, and investors are typically required to put up an initial margin deposit to trade such contracts.
Here are some things you need to know about ES contracts.
What is the value of one contract?
As a forward contract, the price of an ES contract reflects the market’s view of the underlying stock in the future.
In general, ES contracts are expected to trade at a slight premium over the price of one lot of its underlying security.
This premium is due to the cost of carry, which investors typically incur in order to lock in a price when they carry out a trade for settlement at a future date.
However, it is also possible for ES contracts to trade at a discount to the underlying securities. This could be due to negative sentiments.
The prices of both the ES contract and the underlying security usually converge towards the maturity of the ES contract, said Mr. Andrew Ler, SGX senior vice-president and head, private investors.
How do I trade ES contracts?
ES contracts are listed and traded on the SGX. They are bought and sold the same way you transact shares through your broker.
The difference is that you have to put up a margin deposit if you want to trade ES contracts.
This means that you are not required to cough up the full payment for one lot of the ES contracts, but only a fraction of that sum.
The margin set out by SGX for each ES contract ranges from 5 per cent to 20 per cent of the price of its underlying security, and these are stated on the SGX’s website.
Brokerages may choose to charge a higher margin for their own risk management purposes.
For example, an investor buys one lot of a March ES contract on company A, expiring on March 31.
Assuming the share price is $5 and the margin of the ES contract is 10 per cent, he pays $500 for one lot - that is 1,000 shares - of ES contracts.
This is worked out from 10 per cent of $5 x 1,000 shares.
When he settles the contract by taking delivery of company A’s shares on April 3 (the usual three days after the expiry of the contract), he pays the balance of $4,500 - regardless of the price of company A’s shares then.
When do I settle my ES contracts?
ES contracts for the month are listed on the 25th of the preceding month and are available till the last trading day of the contract month.
The settlement is on the third day after the last trading day.
This means that if you are on a long trade, you will receive your shares in your account if you pay for the balance, after deducting the margin you paid for the ES contract earlier.
For short trades, the short- seller has to deliver the shares.
Before settlement, an investor does not own the shares nor the rights associated with owning the shares.
What are the underlying stocks for ES contracts?
You are not able to buy ES contracts for all Singapore-listed stocks.
For a start, 28 securities have been selected as the underlying ones for such contracts after meeting certain requirements such as liquidity, interest from market participants and market capitalisation, or total value.
This is determined by the share price multiplied by the total shares in the market.
Except for three issues (ComfortDelGro, SMRT Corp and an exchange-traded fund (ETF) tracking the STI), the other 25 shares are component stocks of the benchmark Straits Times Index (STI).
Which broking firms support ES contracts?
The 10 stockbroking firms that offer trading in ES contracts are AmFraser Securities, CIMB-GK Securities, DBS Vickers Securities, DMG & Partners Securities, Kim Eng Securities, Lim & Tan Securities, OCBC Securities, Phillip Securities, UOB Kay Hian and Westcomb Securities.
How do I profit from ES contracts?
Below are four trading scenarios.
Case 1: Basic short trade
The investor believes the ES contract price will fall, and he wants to short-sell it.
An investor who is bearish on company B sells one lot of company B March ES contract at the price of $5. The price of the ES contract closes unchanged that day, but falls to $4.50 10 days later.
The investor takes profit by settling his ES contract position via buying the same ES contract at $4.50.
In doing so, he made gains of $500. This is calculated from ($5-$4.50) x 1,000 = $500.
This gain is not possible in conventional share trading, if we assume the share price remains the same during the trading day.
Furthermore, the short-seller has to first borrow the shares, or buy them back, to cover his short position within the same day or suffer a penalty.
He would not have made a profit as the share price closed unchanged that day.
Case 2: Basic long trade
The investor expects the ES contract price to rise, and he wants to ‘long’ the contract.
An investor who is bullish on company C buys one lot of company C March ES contract at the price of $7.
When the market rises, the investor closes his long position by selling the ES contract at the price of $8 to take profit of $1,000.
This is calculated from ($8-$7 = $1)x 1,000 shares = $1,000.
As he pays only a margin to trade, his returns in percentage terms are magnified.
Assuming the margin for this contract was 5 per cent of the underlying share price, he would have paid only $350 for this trade instead of $7,000.
This allows him to make a profit on a much smaller outlay, compared to conventional share trading.
Case 3: ES contract trading at a premium
If an investor feels that an ES contract on company D is trading at too high a premium compared with its underlying share, he can short-sell the ES contract, say at $8.40, and buy the underlying share itself, say at $8, or settle it with the underlying shares that he may already own.
When the ES contract is due for settlement, he can deliver the shares that he already has or has bought.
Assuming he bought one lot, he makes a profit of $400.
This is calculated as ($8.40-$8) x 1,000 shares = $400.
Investors who already own the underlying shares may want to explore this scenario to see if they can secure higher prices for their shares, rather than just selling them in the stock market.
However, they would receive the proceeds only when the contract matures.
Case 4: ES contract trading at a discount
When an ES contract is trading below its underlying security, investors who hold the stock can sell it and buy the ES contract to take advantage of arbitrage opportunities - that is, price differences.
Suppose an investor sells one lot of company E shares at $8.40, and buys its ES contract at $8.
When the ES contract is due for settlement, he takes delivery of one lot of its underlying shares at $8, the price he bought the ES contract for.
He makes a profit of $400. This is calculated from ($8.40-$8) x 1,000 shares = $400.
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When to settle stock deals? It’s your call
Extended settlement gives investors more flexibility in making short and long trades
By Lorna Tan
15 February 2009
Many retail investors have been stunned by the wild price swings seen in the stock market in the wake of the financial crisis and resulting economic gloom.
In such volatile conditions, it is no wonder that investors brave enough to stay in the market are finding it a challenge to pick stocks with a decent chance of gaining.
It is tempting to want to short- sell a specific stock, particularly when you hold a bearish view of its prospects and believe that there would be a substantial downside in its price.
Why would investors want to short-sell, and just what is this anyway?
In short-selling, a trader sells a stock he does not own in the hope of a price fall. If all goes well, when he later buys at a price lower than his selling price - in order to deliver on the sale - he is able to pocket the difference.
However, current rules require the short-seller to deliver his shares by buying them in the market by the end of the trading day, failing which he is slapped with an initial fine of $1,000 or 5 per cent of the trade (whichever is higher) for each failed delivery of securities.
Another way to avoid the penalty is to borrow the shares.
With this in mind, investors with hardy nerves for investing in rocky times may want to check out a new investing tool that offers more flexibility for both short and long trades.
On Friday, the Singapore Exchange (SGX) will be launching extended settlement (ES) contracts, which are also known as forward contracts.
The new product allows investors to buy or short-sell any of 28 securities listed on the SGX at the transacted price on the day of the trade for settlement at a specified future date.
Each ES contract is for 35 days or thereabouts, and investors are typically required to put up an initial margin deposit to trade such contracts.
Here are some things you need to know about ES contracts.
What is the value of one contract?
As a forward contract, the price of an ES contract reflects the market’s view of the underlying stock in the future.
In general, ES contracts are expected to trade at a slight premium over the price of one lot of its underlying security.
This premium is due to the cost of carry, which investors typically incur in order to lock in a price when they carry out a trade for settlement at a future date.
However, it is also possible for ES contracts to trade at a discount to the underlying securities. This could be due to negative sentiments.
The prices of both the ES contract and the underlying security usually converge towards the maturity of the ES contract, said Mr. Andrew Ler, SGX senior vice-president and head, private investors.
How do I trade ES contracts?
ES contracts are listed and traded on the SGX. They are bought and sold the same way you transact shares through your broker.
The difference is that you have to put up a margin deposit if you want to trade ES contracts.
This means that you are not required to cough up the full payment for one lot of the ES contracts, but only a fraction of that sum.
The margin set out by SGX for each ES contract ranges from 5 per cent to 20 per cent of the price of its underlying security, and these are stated on the SGX’s website.
Brokerages may choose to charge a higher margin for their own risk management purposes.
For example, an investor buys one lot of a March ES contract on company A, expiring on March 31.
Assuming the share price is $5 and the margin of the ES contract is 10 per cent, he pays $500 for one lot - that is 1,000 shares - of ES contracts.
This is worked out from 10 per cent of $5 x 1,000 shares.
When he settles the contract by taking delivery of company A’s shares on April 3 (the usual three days after the expiry of the contract), he pays the balance of $4,500 - regardless of the price of company A’s shares then.
When do I settle my ES contracts?
ES contracts for the month are listed on the 25th of the preceding month and are available till the last trading day of the contract month.
The settlement is on the third day after the last trading day.
This means that if you are on a long trade, you will receive your shares in your account if you pay for the balance, after deducting the margin you paid for the ES contract earlier.
For short trades, the short- seller has to deliver the shares.
Before settlement, an investor does not own the shares nor the rights associated with owning the shares.
What are the underlying stocks for ES contracts?
You are not able to buy ES contracts for all Singapore-listed stocks.
For a start, 28 securities have been selected as the underlying ones for such contracts after meeting certain requirements such as liquidity, interest from market participants and market capitalisation, or total value.
This is determined by the share price multiplied by the total shares in the market.
Except for three issues (ComfortDelGro, SMRT Corp and an exchange-traded fund (ETF) tracking the STI), the other 25 shares are component stocks of the benchmark Straits Times Index (STI).
Which broking firms support ES contracts?
The 10 stockbroking firms that offer trading in ES contracts are AmFraser Securities, CIMB-GK Securities, DBS Vickers Securities, DMG & Partners Securities, Kim Eng Securities, Lim & Tan Securities, OCBC Securities, Phillip Securities, UOB Kay Hian and Westcomb Securities.
How do I profit from ES contracts?
Below are four trading scenarios.
Case 1: Basic short trade
The investor believes the ES contract price will fall, and he wants to short-sell it.
An investor who is bearish on company B sells one lot of company B March ES contract at the price of $5. The price of the ES contract closes unchanged that day, but falls to $4.50 10 days later.
The investor takes profit by settling his ES contract position via buying the same ES contract at $4.50.
In doing so, he made gains of $500. This is calculated from ($5-$4.50) x 1,000 = $500.
This gain is not possible in conventional share trading, if we assume the share price remains the same during the trading day.
Furthermore, the short-seller has to first borrow the shares, or buy them back, to cover his short position within the same day or suffer a penalty.
He would not have made a profit as the share price closed unchanged that day.
Case 2: Basic long trade
The investor expects the ES contract price to rise, and he wants to ‘long’ the contract.
An investor who is bullish on company C buys one lot of company C March ES contract at the price of $7.
When the market rises, the investor closes his long position by selling the ES contract at the price of $8 to take profit of $1,000.
This is calculated from ($8-$7 = $1)x 1,000 shares = $1,000.
As he pays only a margin to trade, his returns in percentage terms are magnified.
Assuming the margin for this contract was 5 per cent of the underlying share price, he would have paid only $350 for this trade instead of $7,000.
This allows him to make a profit on a much smaller outlay, compared to conventional share trading.
Case 3: ES contract trading at a premium
If an investor feels that an ES contract on company D is trading at too high a premium compared with its underlying share, he can short-sell the ES contract, say at $8.40, and buy the underlying share itself, say at $8, or settle it with the underlying shares that he may already own.
When the ES contract is due for settlement, he can deliver the shares that he already has or has bought.
Assuming he bought one lot, he makes a profit of $400.
This is calculated as ($8.40-$8) x 1,000 shares = $400.
Investors who already own the underlying shares may want to explore this scenario to see if they can secure higher prices for their shares, rather than just selling them in the stock market.
However, they would receive the proceeds only when the contract matures.
Case 4: ES contract trading at a discount
When an ES contract is trading below its underlying security, investors who hold the stock can sell it and buy the ES contract to take advantage of arbitrage opportunities - that is, price differences.
Suppose an investor sells one lot of company E shares at $8.40, and buys its ES contract at $8.
When the ES contract is due for settlement, he takes delivery of one lot of its underlying shares at $8, the price he bought the ES contract for.
He makes a profit of $400. This is calculated from ($8.40-$8) x 1,000 shares = $400.
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