Table of Contents
1 . Cash Settlement or Deliverable Settlement 2 . Costs and Popularity of Cash vs. Physical Settlement
In commodity exchange, any transaction is settled based on a cash or physical delivery. Every commodity trader should understand the difference between these two modes of settlement. We have compared and explained cash settlement and deliverable settlement so you can decide which option suits you the best. For spot trading in agricultural commodities, check out Agrodity.
Cash Settlement or Deliverable Settlement
The modes of settlement for commodity exchange contracts can be either of these two methods, but what are those? Let’s explore:
Cash Settlement
The method of settling a commodity through this method doesn’t require physical delivery of the commodity in question. Rather, it settles the transaction based on cash on the date of settlement.
The contract holder or purchase pays the net amount of cash on the specified date to carry out commodity settlement. The net amount is the difference between the SP (spot price) and FP (future price) of the underlying asset or commodity.
Deliverable Settlement
Deliverable settlement is the physical delivery method of settling a commodity exchange. This means the asset under consideration is literally delivered on the date of settlement.
The physical settlement process is settled and coordinated with the help of a clearing agent or a broker. If the buyer or contract holder chooses to take a short position, they’re held responsible for the delivery of the underlying asset.
If the contractor decides to take a long position, they will receive the physical delivery of the said commodity.
Costs and Popularity of Cash vs. Physical Settlement
Generally, cash settlement is a popular option due to its instantaneity and convenience. Cash-settled commodity exchanges are more liquid which is another reason many traders opt for this method.
Additionally, most financial derivatives are settled via cash, which again contributes to its popularity. Cash settlement is simple, involving an upfront net amount as the total settlement cost. There are no additional fees or costs involved in the transaction.
Due to this popularity, more traders enter the commodity exchange market to amplify its liquidity and, ultimately, make it a sought-after settlement method.
Compared to that, physical delivery is more popular for equity options. It incurs delivery costs, brokerage fees and transportation costs, to name a few. All of these factors make it less popular among commodity exchanges.
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