What Is a Delivery Point?
The delivery point, in futures contracts or other derivatives, is the location where the physical commodity underlying the contract will be delivered. The futures contract buyers who maintain their position must be ready to accept the delivery and pay the agreed-upon price for the physical commodity. However, the delivery point applies only to future contracts that stipulate the physical delivery of the asset. Contracts that are cash-settled do not engage in physical delivery.
- A delivery point is an agreed-upon location where the underlying asset related to an expired derivatives contract is physically delivered from the short to the long.
- Futures contracts will specify a standardized commodity to be delivered at a specific delivery point (or points if multiple geographic locales exist).
- Depending on the commodity to be delivered, storage and delivery costs will vary and be reflected in the price of the derivatives contract.
Understanding Delivery Points
The delivery point 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.
The majority of futures market participants trade speculatively, and most don’t consider taking delivery of the physical commodities in futures contracts. These speculative buyers purchase futures contracts because they believe the price of the underlying commodity will rise, not because they’re interested in taking delivery of several thousand barrels of oil or several thousand heads of cattle. Taking delivery requires having the resources to store and market these resources to potential end buyers.
Buyers of futures contracts who wish to receive the physical commodity are frequently hoping to lock in a price on the commodity they use in production. By buying a futures contract, they hope to reduce the risk of adverse price movements in an asset.
Examples of Delivery Points
The delivery point is most often a significant transportation hub for the commodity transacted. The change in prices due to the delivery point is readily observable in gasoline prices. If you go on a road trip between cities, you will most often notice gradual changes in the average price of gasoline. Prices are lowest around larger oil refining centers.
- The delivery point for most natural gas and liquefied natural gas (LNG) New York Mercantile Exchange (NYMEX) executed futures is the Henry Hub, a natural gas pipeline located in Erath, Louisiana.
- Corn and soybean futures executed by the Chicago Board of Trade (CBOT) is to terminals on a 204-mile section of the Illinois River
- Live cattle and hogs arrive at various livestock yards and slaughterhouses separated among five regions or territories
- West Texas Intermediate (WTI) crude oil futures exchanged on the NYMEX and have a delivery point at the Cushing Hub in Oklahoma
When delivery takes place, a warrant or bearer receipt—which represents a specified quantity and quality of a commodity in a specific location—changes hands from the seller to the buyer. Full value payment then occurs. The buyer has the right to remove the commodity from the warehouse. Often, a purchaser will leave the product at the storage location and pay a periodic storage fee. Exchanges also set fees for many aspects of the delivery process.
It is crucial to choose the commodity delivery point carefully. Domestic locations may present a set of legal, tax, and regulatory requirements that differ dramatically from those incurred by setting a foreign location as the delivery point. These differences can be significant enough to make a given deal impractical or even impossible.