Futures Delivery Obligations When a Crop Is Destroyed
Summary
The document considers a physically settled crop futures contract when the farmer cannot deliver after a natural disaster destroys the crop. The answer explains that the contract remains in force and that failure to deliver can constitute default, potentially leading to legal proceedings by the exchange. It describes the exchange as the counterparty to each trade and says it would generally obtain crops in the spot market to fulfill delivery to the long side, then seek recovery from the defaulting farmer or follow its rules for allocating any unrecovered cost.
Two ways to avoid delivery default are described: close the futures position by taking an offsetting trade before the final trade date, or buy the required crops in the spot market and deliver them. Closing the position may create a gain or loss and does not replace the destroyed crop. The answer is a general explanation; actual procedures, liability, and loss allocation depend on the contract, exchange rules, and applicable law. It does not discuss insurance or exceptional exchange actions in detail.
Key ideas
- A physically settled futures obligation remains in force even if a disaster destroys the seller's crops.
- Failure to make required delivery may be treated as default and can lead to legal action.
- The exchange may source crops in the spot market to meet its delivery obligation and pursue the seller for costs.
- A trader can close the futures position before the final trade date or buy crops in the spot market for delivery.
- Specific outcomes depend on the contract terms, exchange rules, and applicable law.
Tags
Full text
# What happens to farmers' futures contracts if a natural disaster destroys their crops? # What happens to farmers' futures contracts if a natural disaster destroys their crops? Suppose I am a farmer who entered into a futures contract to deliver crops in 6 months. Suppose that a natural disaster destroyed all my crops just before the delivery date. As a result, it will be impossible for me to deliver. What happens to me, the other party, and the futures contract? Do I default on my obligations? Will the other party be compensated? ## Answer by ThatDataGuy (score 0, accepted) https://quant.stackexchange.com/a/53481 To answer your questions in turn: > What happens to me, the other party, and the futures contract? Nothing happens to you initially. The other party is the exchange - nothing happens to exchange initially. Nothing happens to the contract - it's still valid. > Do I default on my obligations? If the contract is has final settlement via physical delivery and you don't deliver, then yes you have defaulted. The exchange can then take legal proceedings against you. > Will the other party be compensated? The other party of your initial futures contract trade will get their crops delivered as their contract is with the exchange, and the exchange will (almost certainly) not default. They will do this by buying the crops in the spot market and pass it on to the holder of the long contract. If for some reason the exchange never gets compensation from you, the cost will be borne either by the exchange (it is a corporation like any other), or distributed amongst its members, depending on its member rules. However, all this can be avoided if you simply buy the offsetting amount of the futures contract so as to make your open interest on the specified contract zero, before the final trade date. Then you don't have to deliver anything, but you might have lost (or made!) some money on your futures contract in the process. However, you still lost youur crops, so likely you will have lost money. Did you buy weather insurance? :-) EDIT: There is another way you can avoid default with the exchange. On the delivery date, you can buy the crops in the spot market and then deliver them.
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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.