Stocks and Commodities Magazine

Are there any benefits to trading cash settled futures contracts?

What are cash settled futures contracts, are there any special considerations when trading them?

By definition, a futures contract is an agreement between a buyer and a seller to exchange the underlying asset at a specified price, and at a specific date in the future. For example, the buyer of a December 2014 corn futures contract is agreeing to purchase 5,000 bushels of corn at contract expiration in the middle of December. The person on the other side of the trade, the seller of a December 2014 corn, is agreeing to make delivery to the buyer at that time. However, very few traders actually hold their futures contracts to expiration. Instead, they simply offset their position (by taking the opposite action that was taken to enter the trade) and move on to the next trading venture.

Because the typical futures contract represents an actual cash market transaction at its expiration, the futures price and the cash price of the underlying commodity are tied closely together. In essence, this relationship is the glue that keeps market pricing fair and efficient (at least in the long run). Nevertheless, there are a handful of futures contract that are not tied to a deliverable asset at expiration; these contracts are known as “cash settled” futures contracts.

In the case of cash settled futures contracts, the buyer and seller of the financial instrument do not make or take delivery of the underlying asset at expiration. Rather they agree to accept the cash credit, or debit resulting from their entry price relative to the final settlement price of the futures contract. For example, if a speculator purchases a futures contract that happens to be cash settled, he will see a positive cash adjustment to his trading account if the final settlement price of the contract is higher than his purchase price. If the settlement price is lower than the original entry price, the account is debited the difference. Of course, simply exiting the trade before expiration avoids this process altogether.

What many don’t realize, however, is that the settlement price is not necessarily the last price at which the futures contract trades before expiring. Instead, the settlement price is determined by an equation intended to link the cash market to the futures market. In essence, the final settlement price is anticipated to represent the cash market value at the time of the futures contract expiration. Accordingly, it is possible for the settlement price to be much higher or lower than the last trading price of the futures contracts. As many traders learn the hard way, the cash settlement process sometimes exposes flaws in the practice.

 

Read more about cash settled futures in the June 2014 issue of Stocks & Commodities Magazine

Share

DeCarley Trading on Twitter

Carley Garner Trading Books

  • All
  • A Trader's First Book On Commodities
  • Carley Garner
  • Carley Garner Books
  • Commodity Trading Book
  • Futures Trading Book
  • Learn To Trade
  • Learn To Trade Commodities
  • Learn To Trade Futures
  • Higher Probability Commodity Trading, new Carley Garner book

    Higher Probability Commodity Trading, new Carley Garner book

    According to Phil Flynn, Fox Business News contributor, this is Carley Garner's "masterpiece"! Order from Amazon today! "A great read for both beginner and advanced commodity traders. Carley nails the seemingly impossible task of leveling the playing field by imparting vital concepts in easy to digest bites ...she doesn't leave out the harsh realities and heartbreak many overzealous speculators face." -- JON NAJARIAN, co-founder NajarianFamilyOffice.com "I love the book... it's an MBA in trading for the
    Read More
  • Third Edition of A Trader's First Book on Commodities, now available

    Third Edition of A Trader's First Book on Commodities, now available

    In the latest edition of Carley Garner's beginners' book on commodities, she details everything you need to know about futures and options trading before placing a trade.  BUY NOW In their quest for trading commodities profitably, beginning traders spend a substantial amount of time studying market theory, various types of market analysis, and paper-trading in the futures and options markets.  Yet, almost all of them fail to take the necessary steps to ensure their trading
    Read More
    • A Trader's First Book On Commodities
    • Carley Garner
    • Carley Garner Books
    • Commodity Trading Book
    • Futures Trading Book
    • Learn To Trade
    • Learn To Trade Commodities
    • Learn To Trade Futures
  • Commodity Options the Book

    Commodity Options the Book

    It isn't free, but it's close! If this book saves you 2 ticks, you've recouped your investment.   Commodities are hot, as Jim Rogers would say.  Stagnant stocks and the massive bull rally in raw commodities have lured much of the attention away from Wall Street and toward down-town Chicago.  It is difficult to turn on the television or open the newspaper without being reminded of the impact that commodity prices have on our daily lives.   Traders
    Read More
  • Currency Trading in the FOREX and Futures Markets

    Currency Trading in the FOREX and Futures Markets

    Get a copy of Carley Garner's latest book at Amazon.com, or any major outlet! "Once again, Carley Garner demonstrates her ability to boil down complex concepts for individual traders. Trading Currencies in the FOREX and Futures Market will put budding currency traders ahead of the curve with its unique blend of the basics and some refreshingly unexpected material." ~ Karris Golden, Traders Press® "Carley is a smart trader and broker; she understands the markets and the importance of
    Read More

Newsletter Trial