Physical Delivery
Contents
Exploring Physical Delivery in Options and Futures Contracts
Understanding the intricacies of physical delivery is crucial for participants in options and futures markets. Unlike cash-settled contracts, physical delivery requires the actual underlying asset to be exchanged upon contract expiration. Let's delve into the concept of physical delivery, its implications, and how it operates in real-world scenarios.
Deciphering Physical Delivery
In the realm of derivatives, contracts can either be cash-settled or physically delivered upon expiration. Cash-settled contracts involve the transfer of a net cash position between the contract parties, based on the contract's value relative to the spot price at expiration. On the other hand, physical delivery entails the actual transfer of the underlying asset on a predetermined delivery date.
Illustrating with Examples
Consider a scenario involving E-mini S&P 500 futures contracts. If the futures price at expiration differs from the spot price, cash settlement occurs, with gains or losses credited or debited accordingly. In contrast, with physical delivery, as seen in Crude Oil futures contracts, the buyer is obligated to purchase a specified quantity of the commodity at the agreed-upon price, irrespective of the spot price at expiration.
Logistics of Physical Delivery
Exchanges dictate the conditions of physical delivery, including designated warehouse and delivery locations. Upon delivery, a warrant or receipt representing the commodity changes hands, with the buyer having the option to transport the commodity or leave it at the storage facility. Quality standards for the underlying asset are also regulated by exchanges.
Real-world Application
While most derivatives contracts are traded out before expiration, physical delivery remains common in commodity and bond markets. Traders holding short positions in physically settled contracts must either deliver the underlying asset or purchase it at market price if they do not already own it.