What Is Delivery?
In the financial markets, the term “delivery” refers to the act of transferring a commodity, currency, security, cash or another instrument that is the subject of a contract. It is often used in relation to derivative contracts such as futures and options.
In some cases, the buyer of a contract may receive physical delivery of the underlying commodity, such as barrels of oil in the case of a crude oil futures contract. Oftentimes, however, the contract is settled financially meaning that cash is transferred instead of the underlying physical commodity.
- Delivery refers to the act of transferring an underlying asset once a derivative contract has reached its maturity date.
- It is often used in relation to options and futures.
- Most traders in the derivative markets do not intend to take physical delivery of the underlying asset, in which cash they settle in cash instead.
How Delivery Works
When two parties come together to enter into a contract, they must agree to several key clauses, two of which being the price of the contract and the date on which the contract matures. Once the maturity date is reached, the seller is required to either deliver the underlying commodity to the buyer, or else settle the contract for either a gain or a loss.
Depending on the type of commodity in question, there may be different ways that traders typically navigate delivery. For example, in the foreign exchange market, it is common for holders of currency futures contracts to physically settle their contract by delivering the underlying currency. In the case of a stock options contract, on the other hand, it is more common for holders to settle their contracts in cash rather than delivering the specific shares of stock that were the underlying asset for the option.
The choice of how to handle delivery also depends on the type of trader in question. Certain firms, such as oil refineries that rely on oil for their production, might take physical delivery when their contracts mature. These buyers would already have the infrastructure in place to take physical delivery, such as trucks and storage vats in the case of crude oil. Speculative buyers, on the other hand, will not take physical delivery. Instead, they will simply hope to profit from a rise in the price of the underlying commodity, and will look to settle their contract in cash by selling their contract to a third party before it expires.
Real World Example of Delivery
ABC Foods is a food products manufacturer that relies on corn for its production process. To help avoid being surprised by a sudden jump in the price of corn, ABC Foods decides to purchase one year’s supply of corn ahead of time, by using the commodity futures markets. To that end, ABC Foods purchases futures contracts on corn that expire once per month for the following year. Each month, it intends to take physical delivery of the underlying corn.
In making these transactions, ABC Foods’s counterparties consist mainly of speculative traders. These traders think that the price of corn will likely decline during the following year, so they are happy to sell corn futures contracts at today’s market price. In this situation, the corn futures contracts that ABC Foods is a party to will be settled through physical delivery. However, if ABC Foods was not intending to take delivery themselves, the contracts could be settled in cash instead.