Stocks & Commodities V. 32:6 (45): Futures For You by Carley Garner
Product Description
Futures For You by Carley Garner
“CASH-SETTLED” FUTURES CONTRACTS
What are “cash-settled” futures con-tracts? 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 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 contracts that are not tied to a deliverable asset at expiration; these contracts are known as cash-settled futures contracts.
“CASH-SETTLED” FUTURES CONTRACTS
What are “cash-settled” futures con-tracts? 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 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 contracts that are not tied to a deliverable asset at expiration; these contracts are known as cash-settled futures contracts.
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