How Futures Settlement Prices Work at Expiration
Summary
The document explains the apparent conflict between two descriptions of futures: one says the delivery price is agreed when the contract is entered, while another refers to the futures quote on the delivery date. It resolves this by distinguishing the contract’s daily mark-to-market cash flows from physical settlement. The futures buyer pays no purchase price when entering the contract; variation margin reflects changes in the quoted futures price over time.
By expiration, the futures quote converges to the spot price of the underlying. For a cash-settled contract, the final variation-margin payment completes settlement. For a physically settled contract, the holder pays the delivery-date price and receives the asset, an exchange at the prevailing market value. This explanation is conceptual and focuses on the mechanics described; it does not cover contract-specific settlement rules, costs, or exceptions.
Key ideas
- Entering a futures contract does not require paying its quoted price upfront.
- Daily variation margin transfers gains or losses as the futures quote changes.
- At expiration, the futures price equals the underlying asset’s spot price under the explanation given.
- Physical delivery exchanges the asset for its on-market value, while cash settlement ends with the final margin payment.
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Full text
# Definition of Financial Futures: The price to pay for the underlying asset on delivery date # Definition of Financial Futures: The price to pay for the underlying asset on delivery date According to the opening paragraph of the Wikipedia article for "Futures contract", the parties to a futures contract > initially agree to buy and sell an asset for a price agreed upon today (the forward price) with delivery and payment occurring at a future point, the delivery date. However, later in the same article, a formal definition of a futures contract is given, attributed to Björk, which states that, if $F(t, T)$ designates the quoted market price at time $t$ of a futures contract for delivery of $J$ at time $T$, then, in particular, > At time $T$, the holder pays $F(T,T)$ and is entitled to receive $J$. Note that $F(T,T)$ should be the spot price of $J$ at time $T$. So, I'm confused: is the amount to be payed on delivery date in exchange of the underlying asset determined on the day that the futures contract is entered, as the opening paragraph indicates, or is it determined by the market quote on the day of delivery, as Björk's definition indicates? ## Answer by dm63 (score 3, accepted) https://quant.stackexchange.com/a/25003 I think there's confusion here. If a futures contract whose maturity is T is trading at F(t,T) at time t, then the buyer at time t pays no cash at time t, he just "enters into" the contract. At time t+1 he receives an amount F(t+1,T) - F(t,T) of variation margin, and this occurs every day until time T when he receives an amount F(T,T) - F(T-1,T) of variation margin. By definition the value of F(T,T) is the spot price of some asset J at time T. Thus the total cash received over time is F(T,T)-F(t,T). (this may be negative of course). At expiration T, if it is cash settled nothing else happens. If it is physical settled, the holder pays F(T,T) and receives the asset J, although this settlement does not create any positive or negative value because it is an on-market transaction.
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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.