2.6 Delivery Notices, EFPs, Exercise, and Assignment
Key Takeaways
- A physically delivered contract uses exchange rules for notice, assignment, deliverable grade, location, delivery instruments, and final payment; a cash-settled contract terminates through a final index-based cash adjustment.
- The short initiates physical delivery by issuing notice through its FCM and clearing member, and the clearing organization assigns the delivery obligation to a long according to exchange procedures.
- An exchange-for-physical combines a bona fide cash-market transaction with an opposite futures transaction and must be documented and reported under exchange rules.
- Exercise of a call on futures creates a long futures position for the buyer; exercise of a put creates a short futures position, with writers assigned the opposite positions.
2.6 Delivery Notices, EFPs, Exercise, and Assignment
A trader who does not offset before the applicable deadline remains bound by the contract's settlement terms. Series 3 questions therefore distinguish offset, cash settlement, physical delivery, and the special privately negotiated transaction known as an exchange-for-physical. The exact calendar and document names depend on the exchange contract; use the contract specifications rather than assuming every market follows the same dates.
Four Ways a Position Can Change or End
- Offset: A long sells the same contract month or a short buys the same contract month. The clearing system nets the opposite positions. Any accumulated gain or loss has already moved through daily variation settlement, and the position is closed.
- Cash settlement: At expiration, a cash-settled contract is valued against the contract's final settlement index or rate. The clearinghouse transfers the final cash difference and no warehouse receipt, commodity, or security changes hands.
- Physical delivery: A short that remains open delivers under the contract's grade, location, timing, and documentation rules; an assigned long pays and receives the delivery instrument or asset.
- Exchange-for-physical (EFP): Two eligible parties pair a bona fide cash commodity transaction with an opposite futures transaction and report the package under exchange rules.
Offset is a futures transaction on the exchange. Physical delivery is performance under the contract. An EFP is not simply an off-exchange futures trade disguised as a cash deal; the related cash-market component must be genuine and records must support the transaction.
Physical Delivery Sequence
Notice and Assignment
The short controls the initial delivery decision because the short has the obligation to deliver. The short gives an intention-to-deliver notice through its FCM or clearing member. The notice moves through the clearing organization, which assigns it to a long under the exchange's assignment procedure. A customer long does not choose the particular short counterparty.
A delivery notice identifies the contract, quantity, delivery instrument, grade or quality, and other information required by the exchange. Once issued and assigned, the parties and their clearing members must meet the payment and delivery timetable. Traders who lack the operational ability or desire to make or take delivery should close before the relevant first notice day, spot-month restriction, or last trading day specified by the contract.
Delivery Instruments and Quality Adjustments
Physical delivery often occurs by transferring a document of title rather than unloading a commodity into the buyer's office. Depending on the contract, the instrument may be a warehouse receipt, shipping certificate, warrant, or other exchange-recognized document. The instrument represents an approved quantity at an approved facility.
The contract names a par grade and may permit alternate grades at stated premiums or discounts. A higher deliverable grade can command a premium; a lower permitted grade can carry a discount. Location differentials, storage charges, load-out rules, and accrued interest for deliverable financial instruments can also affect the invoice. The futures settlement price alone is therefore not always the final invoice amount.
Delivery Risk for Longs and Shorts
A long that receives notice must be able to pay the invoice and accept the delivery instrument. A short must own or obtain an eligible instrument and satisfy all tender rules. A locked-limit market does not erase these duties. FCM customer agreements commonly allow the firm to liquidate or transfer positions before notice periods when the customer lacks funds or delivery capability.
Exchange-for-Physical Transactions
An EFP has two linked legs:
- A cash-market purchase, sale, or qualifying ownership transfer in the underlying or a closely related commodity.
- An opposite futures transfer between the same parties: the cash buyer normally sells futures to the cash seller, and the cash seller normally buys futures from the cash buyer.
Example: A grain merchant is short 20 corn futures and agrees to sell physical corn to a processor that is long 20 futures. In the EFP, the merchant sells the cash corn and buys the processor's futures; the processor buys the cash corn and sells its futures. Both futures positions close while the parties negotiate the cash terms privately. They must retain documents showing the cash commodity, quantity, parties, and relationship to the futures leg, and the futures portion must be reported as the exchange requires.
EFPs can facilitate commercial transfer outside the standardized delivery mechanism. They do not eliminate anti-fraud, recordkeeping, position-limit, reporting, or exchange-rule obligations.
Futures Option Exercise and Assignment
For a typical option on a futures contract:
| Exercised Option | Option Buyer Receives | Assigned Writer Receives |
|---|---|---|
| Call | Long futures at the strike price | Short futures at the strike price |
| Put | Short futures at the strike price | Long futures at the strike price |
The resulting futures positions are immediately subject to margin and mark-to-market. If a call with a $70 strike is exercised when futures settle at $76, the call buyer receives a long at $70 and is credited the $6-per-unit difference through settlement; the assigned call writer receives the opposite short and debit. Exercise is different from selling the option to close: an offsetting option sale realizes the option's market value without creating a futures position.
Some contracts or options use cash settlement instead. Always read the specification. The exam's safe sequence is: identify whether the instrument is physically or cash settled, identify who initiates the action, determine the resulting position, and then calculate the marked-to-market amount.
In the standard physical-delivery process, which party initiates delivery by submitting an intention-to-deliver notice through the clearing system?
A cash buyer and cash seller use an EFP to close opposite futures positions. What feature is essential?
A customer exercises a put option on a futures contract. What positions result?