What Is Cost of Tender?
Cost of tender is the total charges associated with the delivery and certification of commodities underlying a futures contract. The cost of tender represents the total costs related to taking the physical delivery of a commodity. These costs are assessed only if the futures contract holder wishes to receive the commodity rather than close the position prior to expiration.
- Cost of tender refers to the sum of costs related to the storage and physical delivery of commodities obligated under a derivatives contract.
- Cost of tender may be incorporated into the basis, or difference in price, between the futures contract and the spot market.
- In many cases, derivatives traders will close out or roll over expiring positions to avoid physical delivery, and avoid incurring costs of tender.
Cost of Tender Explained
The cost of tender is essentially the cost of doing business. Any costs associated with the actual physical delivery of the commodity comprise the cost of tender. For example, if an investor is long corn (owns a futures contract on corn), the seller must deliver the corn to the contract holder when the contract expires (unless the contract holder closes the position prior to expiration). The holder must compensate the seller for the cost of tender including transportation, carrying costs, and any other expenses that are associated with the delivery.
In all types of financial markets, to "tender" means to give notice, in this case to an exchange's clearinghouse, that delivery of the physical commodity underlying the futures contract will begin. Most investors who invest in commodity futures choose to close their positions before expiration, so they aren't financially responsible for delivering the commodity. This way, an investor can benefit from movement in the commodity price without having to deal with the major complications of taking physical delivery.
If physical delivery is selected, cost of tender will come into play and will vary based on several factors. The delivery point, for instance, is a vital element in writing futures contracts. The chosen delivery point will affect the net delivery price or cost of the underlying asset. The terms of the delivery underwrite the value of the goods delivered. With physical delivery, the price of commodities differs by location due to the costs of transporting them from their source to the delivery point. Thus, to specify a single price of a commodity for contract purposes, the delivery point is an essential detail.
How Cost of Tender Works
Often, traders will simply roll over a futures contract that is close to expiration to another contract in a further-out month. Futures contracts have expiration dates (while stocks trade in perpetuity). Rolling over helps an investor avoid the costs and obligations associated with the settlement of the contracts. Costs of tender are most often settled by physical settlement or cash settlement. Many financial futures contracts, such as the popular e-mini contracts, are cash settled upon expiration. This means on the last day of trading, the value of the contract is marked to market and the trader’s account is debited or credited depending on whether there is a profit or loss.
Tender charges are usually paid to official warehouses where certification and delivery take place. Sometimes, they can also be due to a clearing house. Tender costs can vary widely between different warehouses, and exchanges are not obligated to enforce limits of any kind on tender charges. Most exchanges will list their costs on their official websites. Sometimes, the exact cost is relayed in the futures contract.