Key points about delivery and cash settlement in futures contracts:
1. **Delivery in Futures Contracts**: Futures contracts are financial derivatives that represent an agreement to buy or sell an underlying asset at a predetermined price on a future date. However, actual delivery of the underlying asset occurs very infrequently in futures trading.
2. **Termination Before Delivery**: Most futures contracts are terminated before the delivery date by making a reverse or offsetting trade in the futures market. This means that the trader can close out their position by taking an opposite position to the one they initially took.
3. **Short Delivering Goods**: In some cases, the short side of the futures contract may decide to deliver the physical goods (commodity, for example) to the long side. The long side, which is often represented by a central counterparty (CCP), accepts the delivery.
4. **Payment on Delivery**: When the long side accepts the physical delivery, they pay the contract price to the short side. The contract price is the price at which the futures contract was initially agreed upon.
5. **Notice of Intention to Deliver**: The specific details of the delivery, such as the location, terms, and details of what is to be delivered, are all specified in the notice of intention to deliver document. Each exchange has its own rules regarding the conditions for submitting an intent to deliver.
6. **Settlement Price for Delivery**: The price paid or received for the delivery will be based on the most recent settlement price of the futures contract. The settlement price is typically determined on the last day of trading before the delivery date.
7. **First Notice Day and Last Notice Day**: In the context of delivery, the first notice day is the first day when a notice to deliver can be made. The last notice day is the last day when a notice to deliver is allowed. These dates are set by the exchange and are important for traders to consider if they intend to make or accept a delivery.
8. **Last Trading Day**: The last trading day is the final day on which a futures contract can be bought or sold in the market. It typically occurs several days before the last notice day, providing traders with time to manage their positions and avoid potential complications with physical delivery.
9. **Cash-Settlement Contracts**: In contrast to physical delivery contracts, cash-settlement contracts do not involve the actual delivery of the underlying asset. Instead, on the last day of trading, the futures account is marked to market based on the settlement price.
10. **Marked to Market**: Marking to market means that the value of the futures contract is adjusted to reflect the current market price of the underlying asset. Profits or losses are realized daily as the settlement price changes, and the account balance is updated accordingly.
**Numerical Example**: Let's consider a hypothetical scenario with a crude oil futures contract where the agreed-upon contract price is $70 per barrel. The last trading day is July 25, the last notice day is July 28, and the delivery date is July 31.
1. On July 25, the crude oil futures contract's settlement price is $72 per barrel.
2. If a trader has a long position (buys the contract) and decides to accept physical delivery, they will pay the short seller (who sells the contract) $70 per barrel on July 31, as per the contract's initial price.
3. If the same trader decides to close out their position before the delivery date, they can simply make an offsetting trade in the futures market at the prevailing market price. For instance, if the settlement price on July 28 is $74 per barrel, the trader will realize a profit of $4 per barrel (selling at $74 and buying back at $70) without needing to deal with physical delivery.
4. In the case of a cash-settlement contract, if a trader holds a long position and the settlement price on the last day of trading (July 25) is $72 per barrel, their account will be credited with a profit of $2 per barrel. Similarly, if the settlement price is $68 per barrel, their account will be debited by $2 per barrel.
Remember that actual market conditions and contract specifications may vary, and it's crucial for traders to thoroughly understand the terms and procedures related to delivery and settlement for specific futures contracts they are trading.
Sure! Here are some multiple-choice questions related to futures contracts, delivery, and cash settlement, along with their answers:
**Question 1**: What is the most common way to terminate futures contracts before delivery?
a) Physical delivery of the underlying asset
b) Marking to market
c) Making a reverse or offsetting trade in the futures market
d) Exercising the option
**Answer**: c) Making a reverse or offsetting trade in the futures market
**Question 2**: What happens when the short side of a futures contract decides to deliver the physical goods?
a) The long side pays the contract price to the short side
b) The short side pays the contract price to the long side
c) The contract is terminated without any payment
d) The long side delivers another asset in return
**Answer**: a) The long side pays the contract price to the short side
**Question 3**: Which document specifies the location, terms of delivery, and details of what is to be delivered in a futures contract?
a) Contract agreement
b) Settlement statement
c) Notice of intention to deliver
d) Delivery confirmation
**Answer**: c) Notice of intention to deliver
**Question 4**: What is the settlement price used for in a delivery-based futures contract?
a) To calculate the initial contract price
b) To determine the last trading day
c) To mark the futures account to market
d) To identify the first notice day
**Answer**: c) To mark the futures account to market
**Question 5**: When can a notice of intention to deliver be made in a futures contract?
a) On the first day of trading
b) On the last day of trading
c) On the first notice day
d) On the last notice day
**Answer**: c) On the first notice day
**Question 6**: In a cash-settlement futures contract, how is the final account value determined?
a) Based on the contract's initial price
b) Based on the most recent settlement price
c) Based on the delivery price
d) Based on the last trading day price
**Answer**: b) Based on the most recent settlement price
**Question 7**: What does "marked to market" mean in futures trading?
a) Adjusting the contract price based on market demand
b) Setting the delivery price according to current market conditions
c) Updating the account balance based on the settlement price
d) Closing out the futures position before delivery
**Answer**: c) Updating the account balance based on the settlement price
**Question 8**: Which day is the last day when a notice of intention to deliver can be made in a futures contract?
a) First notice day
b) Last notice day
c) Delivery date
d) Last trading day
**Answer**: b) Last notice day
Please note that these questions are for educational purposes, and the answers are based on the information provided earlier. Always refer to the specific rules and terms of the futures contracts you are trading or studying, as they may vary based on the exchange and the type of contract.
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