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What is the difference between cash settlement and physical delivery?​

​​​​Futures contracts can be settled in two ways:
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  • Cash Settlement – No actual delivery of the asset; traders settle based on price differences.
  • Physical Delivery – The actual asset is delivered to the contract holder.
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Each Futures contract specifies its settlement method, which affects trading strategies, risk management, and market participation.

1. Cash Settlement 

Instead of exchanging the actual commodity or asset, traders settle profits/losses in cash based on the contract's final price.
Used for financial futures (stock indices, interest rates, volatility, etc.) where physical delivery is impractical.

Example: S&P 500 Futures (ES)
  • If an S&P 500 futures contract (ES) is cash-settled, the trader does not receive shares of all 500 companies.
  • Instead, the final profit or loss is credited or debited in cash when the contract expires.

​Advantages of Cash Settlement

No need to handle physical assets (great for financial contracts).
Simplifies the settlement process (fewer logistics & storage concerns).
Better liquidity and ease of trading (no delivery complications).

Disadvantages of Cash Settlement
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  • No exposure to physical assets (useful for those needing actual commodities).
  • Can be influenced by manipulation near expiration (e.g., "marking the close").

2. Physical Delivery 

At contract expiration, the buyer receives the actual commodity or asset, and the seller must deliver it.
Used in commodity futures (oil, gold, corn, cattle, etc.), where the asset is tangible and can be transferred.

​Example: Crude Oil Futures (CL)
  • If a trader holds a crude oil futures contract until expiration, they must take delivery of 1,000 barrels of crude oil.
  • Because most traders don’t want actual barrels of oil, they close their positions before expiration.

Advantages of Physical Delivery

Useful for businesses & producers who actually need commodities (e.g., refineries buying crude oil).
Ensures futures prices stay linked to real supply & demand.

Disadvantages of Physical Delivery
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  • Requires storage, logistics, and handling costs.
  • Not ideal for retail traders, who would rather speculate on price than take delivery.
  • Must be aware of contract expiration dates to avoid unexpected delivery.

Key Takeaways

Cash settlement = No asset delivery, only price difference paid in cash.
Physical delivery = Actual asset is transferred to the contract holder.
Most traders avoid physical delivery by closing positions before expiration.
Financial futures (like stock indices) are cash-settled, while commodities may require delivery.
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