WHAT IS Delivery Instrument
A delivery instrument is a document given to the holder of a futures contact that may be exchanged for the underlying commodity when that future contract expires. It can commonly take the form of a shipping receipt or a receipt from a warehouse holding the commodity. It will specify the type and amount of the specified commodity.
Delivery instruments are transferrable, meaning they can be handed over to a new owner when the holder sells or otherwise transfers ownership of the commodity.
BREAKING DOWN Delivery Instrument
Delivery instruments enable speculators to engage in futures trading without having to directly handle the commodities being traded. Though some futures contracts result in the actual delivery of commodities to the contract holder, many do not. When a person buys a futures contract for a commodity that they do not intend to ever physically receive, they are considered a speculator.
Speculators use futures contracts as investment vehicles but have no intention of receiving the commodity. Instead, they plan to sell the commodity for a profit when the commodity's price goes up in the future. Speculators can do this by transferring the delivery instrument to the new purchaser. This makes rolling futures contracts forward much simpler, because instead of needing to ship, for example, 500 bushels of wheat or 1000 gallons of oil to a new buyer, traders can simply transfer the paper delivery instrument to the new buyer. Meanwhile, the commodity will remain wherever it is housed until a buyer purchases it intending to actually accept the commodity. For example, a shipment of 500 bushels of wheat may trade four or five times through speculators before a cereal company purchases it and has the wheat delivered to its factory.
Delivery Instruments Outside of Speculation
Engaging in futures trading with the intention of receiving the actual commodity is known as hedging. Companies may engage in hedging in order to save money on raw materials in the future. For example, a manufacturing plant may see that the price of steel is currently low. They know that they need 100 tons of steel every month to complete their orders, so they decide to purchase 500 tons of steel at the current low price, to be delivered in three months. By purchasing so much steel while prices are low, the company can improve its profit margins.
In order to do this, the company secures a futures contract through a broker. The broker will provide the company with a delivery instrument for 500 tons of steel to be delivered in three months. The price of steel may rise in the following three months, but the company has locked in the previous low price. When the contract expires, the company will exchange the delivery instrument for 500 tons of steel.