2.2 Daily Mark-to-Market, Settlement Procedures, and Price Limits

2.2 Daily Mark-to-Market, Settlement Procedures, and Price Limits

Commodity futures contracts operate under a daily cash settlement structure known as mark-to-market accounting. Unlike equity options or stocks—where capital gains or losses remain unrealized until position closure—futures contracts generate actual cash flows into or out of account balances at the end of every single trading day.

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Daily Mark-to-Market Accounting

At the close of each trading session, exchange clearing houses determine the official daily settlement price for every active contract month. All open positions are marked against this price:

1. Long Positions: If the daily settlement price is higher than the previous day's settlement price (or entry price), the gain is credited to the long trader's account in liquid cash. If the settlement price is lower, the loss is debited in cash.
2. Short Positions: If the daily settlement price is lower than the previous day's settlement price, the gain is credited in cash to the short trader's account. If higher, the loss is debited in cash.

Before commissions, fees, and external cash flows, futures trading is economically zero-sum between longs and shorts: one side’s market gain corresponds to the other side’s market loss. Daily variation settlement prevents unpaid gains and losses from accumulating bilaterally and reduces credit exposure, but it does not eliminate every clearing or default risk.

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Cash Settlement vs. Physical Delivery

Futures contracts settle through one of two mechanisms upon contract expiration:

1. Cash Settlement

Cash-settled futures contracts do not require the delivery of physical goods or financial securities. Instead, open positions remaining at contract expiration are automatically closed out against a final cash settlement index price.

• Common Cash-Settled Contracts: Stock index futures (e.g., S&P 500, E-mini Nasdaq), short-term interest rates (SOFR futures), volatility indices (VIX futures), and weather derivatives.
• Mechanics: Final profits or losses are calculated on expiration day, cash is transferred between clearing accounts, and positions terminate.

2. Physical Delivery

Physically delivered contracts require the short contract holder to deliver, and the long contract holder to receive and pay for, the specified physical commodity or underlying debt instrument.

• Common Physically Delivered Contracts: Agricultural commodities (corn, soybeans, wheat, live cattle), energy products (crude oil, heating oil), precious metals (gold, silver), and Treasury bonds.
• Delivery Locations: Deliveries occur at exchange-approved warehouses, grain elevators, pipelines, or delivery points (e.g., Cushing, Oklahoma for NYMEX Crude Oil).

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Key Physical Delivery Milestones

For physically delivered contracts, candidates must master three critical dates:

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Daily Price Limits and Market Conditions

Some contracts use daily price limits to constrain extreme one-session moves and support an orderly adjustment process. A limit is a trading control, not a guarantee against losses, margin stress, or clearing risk. A price limit defines the maximum allowable price rise or fall from the prior session's settlement price.

Price Limit Terminology

• Limit Up: The maximum allowable price increase above the previous day's settlement price.
• Limit Down: The maximum allowable price decrease below the previous day's settlement price.
• Locked Market (Limit Bid / Limit Offer): Occurs when the market moves to the price limit and trading activity stalls at that extreme price.
  • Limit Bid (Locked High): Buyers are bidding at the upper limit, but no sellers are willing to offer at or below that price.
  • Limit Offer (Locked Low): Sellers are offering at the lower limit, but no buyers are willing to bid at or above that price.

[!IMPORTANT] Trading Stoppage Myth: A locked market does NOT mean trading is halted by exchange officials. Trading remains open, and trades will execute if a willing counterparty enters an order at or within the limit price. However, no trades can execute outside the price limit band.

Margin Effects and Circuit Breakers

A limit move does not freeze the account's economics. Settlement variation can generate a larger margin call, the exchange or FCM can raise prospective margin, and a customer may be unable to liquidate while the market is locked. Losses can continue when trading resumes or limits expand.

A daily price limit defines the furthest permitted price move for a contract under that day's exchange rule. A circuit breaker instead pauses, restricts, or halts trading after a stated market trigger and may reopen trading under a prescribed process. Equity-index derivatives can be affected by coordinated market-wide circuit breakers. The exact trigger, duration, and reopening procedure are contract- and exchange-specific.

Expanded Price Limits

If a futures contract closes at its daily limit (limit up or limit down) for one session (or consecutive sessions depending on exchange rules), the exchange may implement expanded price limits for the next trading day (e.g., expanding a $0.30/bushel limit to $0.45/bushel). Expanded limits can give prices more room to adjust in a later session, but they do not guarantee liquidity or an immediate end to a locked market.