Closing Futures Contract

LOS
72
d. describe how a futures contract can be terminated by a close-out (i.e., offset) at
expiration (or prior to expiration), delivery, an equivalent cash settlement, or an
exchange-for-physicals;
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Delivery and Cash Settlement of futures contracts

All contract eventually expire. Each contract has a delivery month.

The delivery procedures varies among contracts.

Most non-cash settled financial futures contracts permit delivery any business day of the delivery month.

Delivery is three day sequence. Two business days before the intended delivery day, the holder of the a short position intending to deliver notifies the clearing house of his intention to deliver through his clearing member. This is day is termed position day.

On the next business day, termed the notice of intention day, the exchane selects the holder of the oldest long position to receive delivery. On the third day, the delivery day, delivery takes place and the long position holder pay the short position holder who made the delivery.

For many of the financial futures delivery is consummated by wire transfer as the securities are with depositories and money is with banks.

On cash settled financial futures contracts, the settlement price on the last trading day is fixed at the closing spot price of the underlying instrument. All contracts are market to market at this settlement price and cash settlement takes place.

Offsetting: About 90 per cent of all futures contracts are not delivered.Most of the contracts get closed prior to expiration through a process called offsetting. The futures market is not the best route to acquire the underlying asset. Hence long position holders close their position before delivery month.

Exchange for physicals (EFP): Some contracts are actually delivered through this process. This transaction occurs outside the exchange, and is reported to the exchange and exchange accepts it to offset the positions of long and short position holders.