Cash Settlement

When a futures or options contract expires or is exercised, the seller of the financial instrument does not deliver the real underlying asset (physically) but instead transfers the cash position that goes with it.

What Is a Cash Settlement?

Futures and options contracts are derivative products that are based on an underlying asset, such as a stock or a commodity, and have a value depending on that underlying asset. Contract holders must provide physical commodities or transfer stock in order to fulfill their contractual obligations when futures and options contracts expire or are executed. When a settlement is made in the form of a check, this is referred to as a “cash settlement”.

It would be cumbersome for an investor who goes short on a futures contract of $10,000 worth of silver to physically transfer the silver to another investor when the contract ends. So, futures and options contracts can be settled with a cash settlement, where the holder of the position is either credited or debited for the difference between the beginning price and final settlement. This is one way to avoid the problem.

When purchasing a cash-settled cotton futures contract, for example, the buyer is only obligated to pay the difference between the spot price of cotton and the futures price. The physical settlement, on the other hand, involves the actual delivery of the underlying instrument(s).

Roles of Cash Settlement

  • The market relies heavily on cash settlement since it increases market liquidity and enables more investors to participate in the market without having to have a stake in a specific security.
  • Any buyer would be unable to acquire the agreed-upon amount of gold on the settlement day since it would be inconvenient for them to do so. As a result, trading becomes more accessible, which in turn leads to increased activity on the market.
  • Due to the fact that contracts are paid in cash, there is only one transaction required to occur at the end of the contract, which reduces costs. Additionally, as there is no physical delivery required, this results in significant time and cost savings for the market.
  • Even though cash-settled accounts require margins to trade and they must maintain a minimum amount in the account to allow for market trading, they are just as safe as cash-settled accounts.

Cash Settlement vs. Physical Settlement

Cash settlement is one of the most popular and frequently used settlement options used in option contracts and futures trading. The best part about cash settlement is that it enables liquidity in the market. This is why it allows more investors to take part in the investment market. A widespread practice in the financial market is for buyers to fix the price of a commodity in order to prevent the possibility of paying higher prices in the future. However, physical settlement deals involving commodities are also popular. The derivatives market relies on a cash settlement to get off the ground and grow its trading volume.

Advantages

As cash settlements only need a margin to establish a position in the market, they incentivize traders to trade more.

On settlement day, there is just one transaction, therefore the transaction cost is very low.

Since the agreements are cash-settled, there is no danger of delivering or purchasing a physical security, which encourages more traders to participate in the market.

Disadvantages

American options can be exercised at any time during the transaction’s life, as compared to European options, which are less flexible since they can be executed only during the maturity period.

Frequently Asked Questions

The second business day following the trade is the regular-way settlement date for common shares. It does not include weekends or holidays in the settlement timeframes, since settlement takes place only during workdays. Investors who want their deals to be completed promptly might opt for a cash settlement.

To get hold of the commodity, the contract holder must either pick it up from the exchange or manufacture it on their own. Cash settlement, on the other hand, does not include the handover of any assets at contract expiration, only the net cash.

In the event that an option is exercised, the two parties involved in the contract must agree on the terms of the agreement.

Related Terms

    Read the Latest Market Journal

    Decoding FX CFD 2.0

    Published on Feb 20, 2024 37 

    This article is aimed at availing information and knowledge essential to intermediate forex traders. It...

    Weekly Updates 19/2/24 – 23/2/24

    Published on Feb 19, 2024 53 

    This weekly update is designed to help you stay informed and relate economic and company...

    Unlock Prosperity with 5 Sure-Fire Financial Instruments!

    Published on Feb 14, 2024 178 

    In Singapore, the concept of guaranteed returns may evoke the spirit of prosperity, reminiscent perhaps...

    Weekly Updates 12/2/24 –16/2/24

    Published on Feb 13, 2024 69 

    This weekly update is designed to help you stay informed and relate economic and company...

    Decoding FX CFD

    Published on Feb 7, 2024 97 

    The foreign exchange market commonly known as the forex or FX market, is a cornerstone...

    Chinese New Year: Three Cases For CFD Trading

    Published on Feb 6, 2024 138 

    The Chinese New Year is a festive season may be celebrated by some parts of...

    Weekly Updates 5/2/24 –9/2/24

    Published on Feb 5, 2024 62 

    This weekly update is designed to help you stay informed and relate economic and company...

    The Intricate Dance of Forex Trading: Unveiling the Psychological Game

    Published on Feb 2, 2024 56 

    Understanding the forex market The foreign exchange market, also known as the forex market, is...

    Contact us to Open an Account

    Need Assistance? Share your Details and we’ll get back to you

    IMPORTANT INFORMATION

    This material is provided by Phillip Capital Management (S) Ltd (“PCM”) for general information only and does not constitute a recommendation, an offer to sell, or a solicitation of any offer to invest in any of the exchange-traded fund (“ETF”) or the unit trust (“Products”) mentioned herein. It does not have any regard to your specific investment objectives, financial situation and any of your particular needs. You should read the Prospectus and the accompanying Product Highlights Sheet (“PHS”) for key features, key risks and other important information of the Products and obtain advice from a financial adviser (“FA“) pursuant to a separate engagement before making a commitment to invest in the Products. In the event that you choose not to obtain advice from a FA, you should assess whether the Products are suitable for you before proceeding to invest. A copy of the Prospectus and PHS are available from PCM, any of its Participating Dealers (“PDs“) for the ETF, or any of its authorised distributors for the unit trust managed by PCM.  

    An ETF is not like a typical unit trust as the units of the ETF (the “Units“) are to be listed and traded like any share on the Singapore Exchange Securities Trading Limited (“SGX-ST”). Listing on the SGX-ST does not guarantee a liquid market for the Units which may be traded at prices above or below its NAV or may be suspended or delisted. Investors may buy or sell the Units on SGX-ST when it is listed. Investors cannot create or redeem Units directly with PCM and have no rights to request PCM to redeem or purchase their Units. Creation and redemption of Units are through PDs if investors are clients of the PDs, who have no obligation to agree to create or redeem Units on behalf of any investor and may impose terms and conditions in connection with such creation or redemption orders. Please refer to the Prospectus of the ETF for more details.  

    Investments are subject to investment risks including the possible loss of the principal amount invested. The purchase of a unit in a fund is not the same as placing your money on deposit with a bank or deposit-taking company. There is no guarantee as to the amount of capital invested or return received. The value of the units and the income accruing to the units may fall or rise. Past performance is not necessarily indicative of the future or likely performance of the Products. There can be no assurance that investment objectives will be achieved.  

    Where applicable, fund(s) may invest in financial derivatives and/or participate in securities lending and repurchase transactions for the purpose of hedging and/or efficient portfolio management, subject to the relevant regulatory requirements. PCM reserves the discretion to determine if currency exposure should be hedged actively, passively or not at all, in the best interest of the Products.  

    The regular dividend distributions, out of either income and/or capital, are not guaranteed and subject to PCM’s discretion. Past payout yields and payments do not represent future payout yields and payments. Such dividend distributions will reduce the available capital for reinvestment and may result in an immediate decrease in the net asset value (“NAV”) of the Products. Please refer to <www.phillipfunds.com> for more information in relation to the dividend distributions.  

    The information provided herein may be obtained or compiled from public and/or third party sources that PCM has no reason to believe are unreliable. Any opinion or view herein is an expression of belief of the individual author or the indicated source (as applicable) only. PCM makes no representation or warranty that such information is accurate, complete, verified or should be relied upon as such. The information does not constitute, and should not be used as a substitute for tax, legal or investment advice.  

    The information herein are not for any person in any jurisdiction or country where such distribution or availability for use would contravene any applicable law or regulation or would subject PCM to any registration or licensing requirement in such jurisdiction or country. The Products is not offered to U.S. Persons. PhillipCapital Group of Companies, including PCM, their affiliates and/or their officers, directors and/or employees may own or have positions in the Products. Any member of the PhillipCapital Group of Companies may have acted upon or used the information, analyses and opinions herein before they have been published. 

    This advertisement has not been reviewed by the Monetary Authority of Singapore.  

     

    Phillip Capital Management (S) Ltd (Co. Reg. No. 199905233W)  
    250 North Bridge Road #06-00, Raffles City Tower ,Singapore 179101 
    Tel: (65) 6230 8133 Fax: (65) 65383066 www.phillipfunds.com