Physical delivery

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Physical delivery in derivatives markets refers to settlement by receiving or sending the underlying assets - stock certificates, head of cattle - to the holder at the contract's maturation date rather than send the cash equivalent (cash settlement). Most derivatives contracts do not result in physical delivery of the underlying product, but are traded out before their delivery date -- that is, the traders close out their positions by buying offsetting contracts. Physical delivery does occur, however, most often with commodities but with other financial instruments as well.

Physically-delivered derivatives contracts are generally subject to much tighter speculative position limits by market regulator the Commodity Futures Trading Commission (CFTC).[1] Speculative limits in physical delivery markets are generally set at a more strict level during the spot month (the month when the futures contract matures and becomes deliverable).

On the last day of trading, physically settled contracts typically experience thin liquidity because traders who do not intend to convert their futures contracts to physical goods have rolled their positions to the next delivery month or just gotten out of the market.[2]

Indian regulators attempted to go a step further in 2002 to dissuade some of the speculation in its derivatives market of the Bombay Stock Exchange (BSE) and require that all single-stock futures contracts be physically delivered.[3] Nonetheless, stock futures and options contracts continue to trade on the BSE on a cash-settled basis.[4]

Resources

  • "A Survey on Physical Delivery Versus Cash Settlement in Futures Contracts," International Review of Economics & Finance, Volume 15, Issue 1: [1]

References

  1. Speculative Limits. CFTC.
  2. Financial settlement vs. physical delivery. Futures Magazine.
  3. Physical settlement for derivatives. The Hindu Business Line.
  4. Derivatives. Bombay Stock Exchange.