Futures contracts have two types of settlements, the MTM (mark to market) settlement, which happens on a continuous basis at the end of each day, and the Final Settlement which happens on the last trading day of the futures contract.
All positions of a CM, brought forward, created during the day, or closed-out during the day, are market-to-market at the daily settlement price or the final settlement price at the close of trading hours on a day.
On the date of expiry, the final settlement price is the spot price on the expiry day. The responsibility of settlement is on a trading cum clearing member for all trades done on his own account and his client’s trades.
A professional clearing member is responsible for settling all the participants’ trades, which he has confirmed to the exchange.
Types of Settlement
Futures contracts have two types of settlements, which are as follows:
Market to Market Settlement
This happens on a continuous basis at the end of each day. All futures contracts for each member are Marked-to- Market (MTM) to the daily settlement price of the relevant futures contract at the end of each day.
The profits/losses are computed as the difference between the following:
- The trade price and the day’s settlement price for contracts executed during the day but not squared up.
- The previous day’s settlement price and the current day’s settlement price for brought forward contracts.
- The buying price and the selling price for contracts executed during the day and squared up.
The CMs who have a loss is required to pay the Mark-to-Market (MTM) loss amount in cash which is in turn passed on to the CMs who have made an MTM profit.
This is known as daily mark-to-market settlement. CMs are responsible for collecting and settling the daily MTM profits/losses incurred by the TMs and their clients, clearing and settling through them.
Similarly, TMs are responsible for collecting/paying losses/profits from/to their clients by the next day. The pay-in and pay-out of the mark-to-market settlement are affected on the day following the trading day.
After completion of the daily settlement computation, all the open positions are reset to the daily settlement price. Such positions become open positions for the next day.
This happens on the last trading day of the futures contract. On the expiry day of the futures contracts, after the close of trading hours, NSCCL marks all positions of a CM to the final settlement price, and the resulting profit/loss is settled in cash.
The final settlement loss/profit amount is debited/credited to the relevant CM’s clearing bank account on the day following the expiry day of the contract.
Settlement Prices for Futures
The daily settlement price on a trading day is the closing price of the respective futures contracts on such a day.
The closing price for a futures contract is currently calculated as the last half an hour weighted average price of the contract in the F&O Segment of NSE.
The final settlement price is the closing price of the relevant underlying index/security in the capital market segment of NSE on the last trading day of the contract.
The closing price of the underlying Index/security is currently its last half-an-hour weighted average value in the capital market segment of NSE.
Delivery generally refers to the changing of ownership or control of a physical commodity under specific terms and procedures established by the exchange upon which the contract is traded and which occurs on or before the last trading day of a futures contract.
Delivery options refer to the options available to the seller of a futures contract, including the quality option, the timing option, and the wild card option.
More broadly speaking, delivery options exist for commodities futures, where the seller has various choices in terms of the deliverable to provide to the buyer of the futures contract.
Delivery options also exist for bond futures contracts. Delivery options make the buyer uncertain of which Treasury bond will be delivered or when it will be delivered.
A delivery option provides a great deal of flexibility for the deliverer of the underlying commodity, but it poses a risk for the investors expecting delivery of the underlying.
It is a feature added to some futures contracts permitting the short position to determine the combination of timing, location, quantity, and quality of the underlying commodity stated in the delivery notice.
Generally, professional traders leave the delivery situation to the commercials and producers. However, some professional traders take delivery intentionally.
For example, consider metal cash and carry transactions — a trader takes delivery of December Gold, placing a forward hedge in June gold.
In this transaction, the professional trader is looking to make a profit by carrying the gold forward from December to June.
The Clearinghouse plays an important role in clearing all the outstanding positions, notifying the buyer of the seller’s intention to deliver, and assigning to the seller of the futures counterparty.
Depending on the type of notice, transferable or not, the futures contract buyer can settle the contract by offsetting his/her transactions or by taking delivery of the underlying.
Moreover, the contract can be closed by an exchange of cash (cash settlement) or physical goods (physical settlement).
Schedule Days for the Delivery
First Notice Day
Every commodity exchange designates the first day on which a seller may tender notice to a buyer, and this is called First Notice Day.
For most commodities, the 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 the first notice day. In some contracts, the first notice day occurs after the last trading day.
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, the 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.
Last Trading Day
The last day a commodity may be traded is called the Last Trading Day. All future 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.
Some financial futures, such as those on stock indices, are settled in cash because it is inconvenient or impossible to deliver the underlying assets.
This procedure takes the place of actually receiving delivery or making the delivery. The cash price is determined by the Exchange and added to the customers’ account to offset the expiring futures contract.
Cash Payment is made based on the underlying reference rate, such as a short-term interest rate index such as Euribor or the closing value of a stock market index.
This is mostly used for settling stock indices futures. Stock indices cannot be delivered physically.
This is because that will involve transactions in constituent stocks (underlying the index) in various proportions, which is not practically possible and involves higher transaction costs.
On the expiry of the settlement period, the exchange sets the final settlement price equal to the spot price of the asset on that day.
For example, suppose an investor takes a long position in near-month NSE Nifty Futures with a delivery price at 3100.
On maturity, if the index is at 3200 with near-month short futures at 3225, then the investor gains 1100 through cash settlement.
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.
There is overnight news in the market, gains or losses from the final! trade price may be dramatically reversed.