What Is a Warehouse Receipt?
A warehouse receipt is a type of documentation used in the futures markets to guarantee the quantity and quality of a particular commodity being stored within an approved facility. Warehouse receipts are important because they serve as proof that the commodity is in the warehouse and that the proper documentation has been verified. Commodities need to meet specific quality standards in order to be traded as a futures contract, and the warehouse receipts play a role in verifying that the necessary requirements have been met.
- A warehouse receipt is used in the futures markets to guarantee the quantity and quality of a commodity being stored in a facility.
- Exchange-approved warehouses are used to provide a secure location to store the physical commodity as well as provide inventory management.
- The warehouse receipt provides the exchange with documentation that the goods authorized for sale are available for transfer to a buyer.
Understanding a Warehouse Receipt
Warehouse receipts are a part of the operational business processing involved with futures contracts for physical delivery. A futures contract is an obligation to buy or sell a commodity or security at a predetermined price at a date in the future. Futures are derivatives because they derive their value from the price of the underlying security or commodity. There are many types of commodity futures, including corn, wheat, oil, gold, and silver. Futures contracts are standardized, meaning they have a set quantity and are deliverable by certain dates throughout the year.
However, futures also have quality standards that must be met and warehouse receipts play a role in the inventory and delivery process of the underlying commodity for the contract. For a commodity to be delivered, to satisfy a futures contract, there must be a warehouse receipt for the goods. Sometimes, instead of the physical delivery of the actual commodities backing a contract, warehouse receipts can be used to settle futures contracts. For precious metals, warehouse receipts may also be referred to as vault receipts.
Commodities for Physical Delivery
Futures contracts are broadly used by all types of companies manufacturing and transporting various types of goods. Some of the most popular futures exchanges include the Chicago Mercantile Exchange (CME), Chicago Board of Trade (CBOT), New York Mercantile Exchange (NYMEX), and the New York Board of Trade (NYBOT). Futures exchanges are used by buyers and sellers to hedge–or protect themselves from–the price volatility of all types of commodities. In some cases, traders may use the futures market to speculate and profit from arbitrage opportunities.
However, the majority of trades made on futures exchanges are done by commercial traders who seek to either sell or buy commodities for physical delivery. Commodities for physical delivery are used to produce and manufacture a wide range of goods that comprise a large portion of the U.S economy’s gross domestic product (GDP). GDP is a measurement of economic growth in an economy.
Futures contracts on commodities differ from plain vanilla options on stocks. Options contracts give the holder the right to buy or sell the underlying stock at a preset price or strike price. While stocks and other underlying exchange-traded securities for options can be easily bought and sold electronically with electronic settlement, futures contracts require the tracking of physical inventory. Also, specific quality standards must be met for a commodity to be physically delivered as a result of a futures contract.
The tracking of physical inventory provides for some important procedures that must be followed by commodity producers. In order for commodity producers to write contracts on their commodity inventory, they must be licensed and registered with the appropriate authorities. Commodity producers must also certificate their physical inventory through a certification process that involves inspection and authentication resulting in a certificated stock approval. Certificated stock can then be used to write contracts on inventory in the futures market.
Each futures exchange has specific delivery and storage requirements that must be met. For example, at the CME, exchange-approved warehouses are the only entities and locations that can deliver against a futures contract.
Exchange-approved warehouses are used to provide a secure location to store the physical commodity. The warehouse also provides the inventory management services for the futures exchange and ensures that any commodities delivered to the warehouse meet the strict specifications, including having the proper certifications. For example, copper and gold would each have their own specific weight and quality requirements that would need to be met before the warehouse could accept a shipment from a refiner or producer.
Warehouse receipts are another operational step taken when a physical commodity is used as backing for a futures contract. A warehouse receipt provides the exchange with documentation that the goods authorized for sale are available and ready for transfer to a buyer. The entity selling their inventory will write a futures contract to sell at a specified price.
Warehouse receipts are required with the writing of a short (or sale) commodity futures contract. The entity that takes the long (or buy) position is assured by the warehouse receipt. The entity with the long position contract at expiration will receive the commodity inventory at the specified price.
If the buyer didn't want to take delivery of all of the commodity, for example, they could ship a partial order to where they need it (such as their store to sell it) and hold the remaining portion in the warehouse. The warehouse receipt would act as ownership for the commodity in storage at the exchange-approved warehouse.