What is a Cash Delivery
Cash delivery is the settlement between buyer and seller at the end of a futures or options contract. Cash delivery does not require the delivery of the underlying asset. The vast majority of futures and options contracts are cash-delivered, as opposed to expecting the physically delivery of the underlying. In the foreign exchange market, cash delivery is the settlement of a contract.
Cash delivery is also known as cash settlement.
BREAKING DOWN Cash Delivery
Cash delivery of options and futures is unlike physically deliver. It is simpler and less expensive to exchange the net cash value of the futures position. This feature allows investors to hedge against price changes in the underlying asset without having to worry about physically taking delivery. Investors who use these investments are known as speculators because they are not interested in possessing the underlying physical asset. Those investors who purchase options and futures with the intent to take possession of the underlying are hedging against future adverse price shifts.
Cash delivery also allows for the trading of assets that cannot be delivered physically, namely indexes, such as the S&P 500® or the Nikkei 225. Yet another advantage of cash delivery is that it has allowed for far more trading of futures and options, providing both market liquidity and a broader choice of financial products.
As an example, Adam buys a cash-delivered futures contact allowing him to purchase 100 head of cattle two months from now for $300 per head, for a total of $30,000. The current price for a head of cattle is also $300. Adam has bought this contract to hedging against the potential of rising prices.
If cattle trade for $350 per head by the contract’s expiration, his cash-delivered futures contract profits by $5000. He can use this to offset the $35,000 he will have to spend if he chooses to purchase 100 head of cattle. However, if the price falls to $250, his cash-delivered futures contract loses $5,000. In this case, if he wants to purchase the 100 head of cattle, he can do so at the market price for $25,000, but he must pay out a total of $30,000, counting the $5,000 cash-delivered futures loss.
Forex Cash Delivery
There is no central marketplace for foreign currency, as trade is over-the-counter. The Forex market is open 24 hours a day, five days a week, except for holidays, and currencies trade worldwide. To participate in foreign exchange trading, the investor must first establish and fund an International Monetary Market (IMM) delivery account. At a contract's end, funds are withdrawn or deposited into the delivery account in the domestic currency.
A spot Forex deal is for immediate delivery, which is two business days for most currency pairs. The major exception is the purchase or sale of U.S. dollars vs. Canadian dollars, which settle in one business day. Weekends and holidays can cause the time between transaction and settlement dates to increase substantially, especially during holiday seasons, like Christmas and Easter. Also, the Foreign exchange market practice requires that the settlement date be a valid business day in both countries.
Foreign exchange forward contracts are a special type of foreign currency transaction. These contracts always take place on a date after the date that the spot contract settles and are used to protect the buyer from fluctuations in currency prices.