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How do settlement prices impact Futures contracts?​

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Settlement price is the official closing price of a Futures contract at the end of a trading session. It is used for:

Marking daily profits & losses 
Margin calculations & risk management 
Determining final settlement for expiring contracts 

What is the Settlement Price?

Definition: The settlement price is the final price determined by the exchange at the close of the trading day.
Purpose: Ensures fair valuation of contracts by removing short-term price distortions caused by volatility at the close.
Calculated By: The exchange (e.g., CME, ICE, Eurex) based on the average price of trades near the close.

Example: Crude Oil (CL) Futures

• If crude oil fluctuates between $75.00 and $75.50 before the close…
• The exchange may set the settlement price at $75.30 (based on the volume-weighted average of final trades).

Why Are Settlement Prices Important?

1. Mark-to-Market Adjustments 

Futures contracts are marked to market daily, meaning traders realize profits/losses daily based on the settlement price.

• If the settlement price moves against a trader's position, they must post additional margin (margin call).

Example: Gold Futures (GC) Trade

• Trader buys a gold futures contract at $2,000.
• Settlement price at close = $1,990 → $10 per ounce loss.
• Since 1 contract = 100 ounces, the trader loses $1,000 for the day.

2. Margin & Risk Management 
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• Clearinghouses use settlement prices to adjust margin requirements.
• If the market moves significantly, margin requirements can increase to reflect higher risk.

Example: E-mini S&P 500 Futures (ES)

• Trader has $10,000 in their margin account.
• If the market drops significantly and the settlement price reduces account value to $8,500, a margin call is issued.

3. Final Expiration Settlement 

• When a futures contract expires, its final settlement price determines cash settlement or physical delivery obligations.
• Some contracts are cash-settled (e.g., S&P 500 futures), while others require physical delivery (e.g., crude oil futures).

Example: Cash-Settled vs. Physical Delivery

• E-mini S&P 500 futures (ES) → Cash-settled at final price.
• Crude Oil (CL) futures → Buyer receives 1,000 barrels if held to expiration.

4. How the 'Settlement Price' is Determined
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The exact method for determining the settlement price varies depending on the exchange and the specific futures contract. Common methods include:

• Volume-Weighted Average Price (VWAP): Calculating the average price of trades during a specific period near the end of the trading day, weighted by the volume of those trades.
• Last Traded Price: Using the price of the last trade of the day (or a specific period).
• Exchange Committee Determination: In some cases, an exchange committee will review trading activity and market conditions to determine a fair and accurate settlement price.

5. Key Impacts of Settlement Prices on Traders

Affects Overnight Risk: Traders holding positions overnight will have gains/losses locked in at the settlement price.
Triggers Margin Calls: If the settlement price moves against a trader’s position, they may need to add more funds.
Influences Expiring Contracts: Traders must roll over or close positions before expiration to avoid delivery.
Used for Risk Models: Large institutions and funds use settlement prices for portfolio valuation & risk analysis.

Key Takeaways

Settlement price = official daily closing price of a futures contract
Used for margin calculations, mark-to-market adjustments, and final settlements
Exchanges determine settlement prices using volume-weighted averages or closing trades
Impacts overnight risk, margin calls, and contract expiration values

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