Methodologies Explained For Settlements In Futures Reduce Font Size Increase Font Size Print This Page Reduce Font Size Increase Font Size Print This Page
IMA - Institute of Management Accountants
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Settlements In Futures Contracts

Settlement in futures is the act of accomplishing the contract, and futures settlements can be done in either of the two ways given below, as precise per type of futures contract:

Physical delivery - the quantity specified of the underlying benefit of the contract is carried by the seller of the contract to the exchange, and through the exchange to the purchasers of the contract. Substantial delivery is frequent with possessions and bonds. In reality, it happens only in a minority of contracts.

The majority are abandoned with buying a covering position - that is, purchasing a contract to cancel out a previous sale (covering a short), or selling a contract to settle a previous purchase (covering a long). The Nymex crude futures contract makes use of this method of settlement in futures upon cessation.

Cash settlement - a cash imbursement is done on the basis of fundamental reference rate, like a small term interest rate index such as Euribor, or the concluding value of a stock market index. For settlement in futures contracts, the parties resolve by paying/receiving the loss/gain associated to the contract in cash on the expiration of the contract.

Cash futures settlements are those that, as a realistic matter, cannot be settled by delivery of the given item - i.e. how would index be delivered? A settlement in futures contract may choose to settle against an index on the basis of trade in an interrelated spot market. Ice Brent futures use this method of futures settlement.

Expiry (or Expiration) is the time period or a day that a specific delivery month of a futures contract discontinues the trading, along with ultimate settlement price for that contract. Usually third Friday of the trading month for several equity index and interest rate futures contracts (as well as for most equity options) this happens. During this day the n+1 futures contract turn into the n futures contract.

For arbitrage desks it’s an exciting period of time, when they try to make immediate profits during the bout (probably 30 minutes) throughout which the principal cash price and the futures price at times struggle to unite. During this time the futures and the main assets are exceptionally liquid and any gap between an index and an underlying asset is rapidly traded by arbitrageurs.

Also at this time there is boost in volume caused by traders undulating over positions for the next contract or, in the case of equity index futures, buying primary components of those indexes to enclose against current index positions. On the expiry date, a European equity arbitrage trading desk in London or Frankfurt will see positions expire in as many as eight major markets almost every half an hour.

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