P.Krishnaveni/Financial Derivatives/MBA/SNSCT Delivery Option Marking to market Final Settlement P.Krishnaveni/Financial Derivatives/MBA/SNSCT

Deliver Option First Notice Day Every commodity exchange designates the first day on which a seller may tender a notice to a buyer, and this is called First Notice Day. For most commodities, first notice day is one to three days before the first business day of the delivery month. To avoid taking delivery, you must be out of your long by the close of the business day prior to First Notice Day. Delivery can take place commencing with first notice day. In some contracts, first notice day occurs after last trading day. P.Krishnaveni/Financial Derivatives/MBA/SNSCT

P.Krishnaveni/Financial Derivatives/MBA/SNSCT Last Notice Day The last day of the delivery period on which sellers may tender a delivery notice to buyers is called the Last Notice Day. In most cases, last notice day is from two to seven business days prior to the last business day of the month. There are, of course, exceptions to this rule which are reflected on the delivery schedule P.Krishnaveni/Financial Derivatives/MBA/SNSCT

P.Krishnaveni/Financial Derivatives/MBA/SNSCT Last Trading Day The last day a commodity may be traded is called the Last Trading Day. All futures contracts outstanding after the last trading day must be satisfied by delivery. Last trading days vary from commodity to commodity, however, most occur during the latter part of the delivery month. P.Krishnaveni/Financial Derivatives/MBA/SNSCT

DELIVERIES BY CASH SETTLEMENT Some commodity contracts are closed out by cash settlement on the last trading day. This procedure takes the place of actually receiving delivery or making delivery. P.Krishnaveni/Financial Derivatives/MBA/SNSCT

P.Krishnaveni/Financial Derivatives/MBA/SNSCT The cash price is determined by the Exchange and added to the customers’ account to offset the expiring futures contract. These particular contracts pose no threat to receiving deliveries and may be carried to expiration with no margin or procedural penalties. This does not mean there is no risk. In most cash settled commodities, the settlement price is determined the following trading day based on whatever criteria have been decided on. For example, in the S&P 500, the settlement is based on the composite of the next day's opening prices in the underlying stocks in the index. If there is overnight news in the market, gains or losses from the final trade price may be dramatically reversed. Since options on most cash settled futures also expire using the same calculation, options, which appeared worthless, may suddenly have value and vice versa. P.Krishnaveni/Financial Derivatives/MBA/SNSCT

P.Krishnaveni/Financial Derivatives/MBA/SNSCT Settlement is the act of consummating the contract, and can be done in one of two ways, as specified per type of futures contract: Physical delivery − the amount specified of the underlying asset of the contract is delivered by the seller of the contract to the exchange, and by the exchange to the buyers of the contract. Physical delivery is common with commodities and bonds. In practice, it occurs only on a minority of contracts. Most are cancelled out by purchasing a covering position - that is, buying a contract to cancel out an earlier sale (covering a short), or selling a contract to liquidate an earlier purchase (covering a long). Cash Settlement − a cash payment is made based on the underlying reference rate, such as a short-term interest rate index such as 90 Day T-Bills, or the closing value of a stock market index. The parties settle by paying/receiving the loss/gain related to the contract in cash when the contract expires. Cash settled futures are those that, as a practical matter, could not be settled by delivery of the referenced item—for example, it would be impossible to deliver an index. A futures contract might also opt to settle against an index based on trade in a related spot market. ICE Brent futures use this method. P.Krishnaveni/Financial Derivatives/MBA/SNSCT

P.Krishnaveni/Financial Derivatives/MBA/SNSCT Expiry (or Expiration in the U.S.) is the time and the day that a particular delivery month of a futures contract stops trading, as well as the final settlement price for that contract. For many equity index and Interest rate future contracts (as well as for most equity options), this happens on the third Friday of certain trading months. On this day the t+1 futures contract becomes the t futures contract. For example, for most CME and CBOT contracts, at the expiration of the December contract, the March futures become the nearest contract. This is an exciting time for arbitrage desks, which try to make quick profits during the short period (perhaps 30 minutes) during which the underlying cash price and the futures price sometimes struggle to converge. At this moment the futures and the underlying assets are extremely liquid and any disparity between an index and an underlying asset is quickly traded by arbitrageurs. At this moment also, the increase in volume is caused by traders rolling over positions to the next contract or, in the case of equity index futures, purchasing underlying components of those indexes to hedge 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. P.Krishnaveni/Financial Derivatives/MBA/SNSCT

P.Krishnaveni/Financial Derivatives/MBA/SNSCT Break….. Logical Questions P.Krishnaveni/Financial Derivatives/MBA/SNSCT

P.Krishnaveni/Financial Derivatives/MBA/SNSCT Offsetting Contracts, Settlements And Delivery There are three ways to close a position in the futures market. Offsetting contracts through liquidation is by far the most popular. Other players will prefer, in certain circumstances, to come to a cash settlement (in index or interest rate markets) or physical delivery (in hard asset markets). You must be aware of each of these procedures in order to be successful in trading futures. P.Krishnaveni/Financial Derivatives/MBA/SNSCT

P.Krishnaveni/Financial Derivatives/MBA/SNSCT Liquidating A "liquidation" – also called an "offset" or a "reversing trade" – completes a futures transaction by bringing an investor's net position back to zero. "Back to zero," by the way, does not suggest that there is no profit or loss. It only means that, if an investor has purchased a specific number of contracts for a specific commodity, for delivery on a specific date, he has sold the same number of contracts for the same commodity for the same delivery date. If, instead, he shorted six October corn contracts, then he must buy six October corn contracts to truly offset the position. The counterparty for the reversing trade is most likely going to be a different person than the counterparty for the initial trade. Still, because all these transactions go through a clearinghouse, the net position is what's important. As long as an investor competently liquidates his position, he will not be obligated to deliver the commodity, nor will he be obligated to take delivery. If the reversal is not precisely matched, though, the effect is that the investor enters into a new obligation instead of canceling out the old one. The resale price of a future contract depends on 1. The current futures price in relation to the option's strike price, 2. The length of time still remaining until expiration of the option and 3. Market volatility. Net profit or loss, after allowance for commission charges and other transaction costs, will be the difference between the premium paid to buy the option and the premium received when it is liquidated. The trick to liquidating a position is to get out of it before the "first notice day," that is, the first day on which notices of intent to deliver actual commodities against futures market positions can be received. First notice day may vary with each commodity and exchange P.Krishnaveni/Financial Derivatives/MBA/SNSCT

P.Krishnaveni/Financial Derivatives/MBA/SNSCT Notices A "notice of intent to deliver" must be presented by the seller of a futures contract to the clearing organization prior to delivery. The clearing organization then assigns the notice and subsequent delivery instrument to a buyer. In specific circumstances, some exchanges permit holders of futures contracts who have received a delivery notice through the clearing organization, to sell a futures contract and return the notice to the clearing organization to be reissued to another long; others permit transfer of notices to another buyer. The trader is said to have engaged in a "retender" of the notice P.Krishnaveni/Financial Derivatives/MBA/SNSCT

P.Krishnaveni/Financial Derivatives/MBA/SNSCT Evaluation P.Krishnaveni/Financial Derivatives/MBA/SNSCT

P.Krishnaveni/Financial Derivatives/MBA/SNSCT Conclusion First Notice Day Last Notice Day Last Trading Day Deliveries by Cash Settlement Notices P.Krishnaveni/Financial Derivatives/MBA/SNSCT