Understanding FX Settlement and Delivery
All futures contracts have a specified date on which they expire. Prior to expiration, traders have a number of options to either close out or extend their open positions without holding the trade to expiration.
For those traders who want to take their contract to expiration, there are two ways an FX contract can be settled: cash settlement or physical delivery of the currency. For many FX futures, the last trading day is generally the second business day prior to the third Wednesday of the contract month.
We will look at a how settlement happens using the March British pound futures, which expire on the third Wednesday of the contract month. This contract is physically-delivered.
Assume on the Monday preceding expiration, the expiring March contract is trading at 1.2405, and the next deferred contract, which is June, is trading at 1.2395.
The price difference between these two contracts is known as a calendar spread.
The calendar spread level is important, because it is a factor in determining the final price of the expiring contract.
In this example the calendar spread would be 10 ticks, a difference of 0.0010. British pound futures stop trading at 9:16 a.m. Central Time (CT) on that Monday.
In the final 30 seconds of trading, between 9:15:30 and 9:16:00 a.m., CME Clearing calculates the volume-weighted average price, for the deferred contract. We will assume the VWAP for the deferred June contract is 1.2390.
The calendar spread is then added to the VWAP to arrive at the final settlement price of the expiring contract of 1.2400.
Now that we have calculated the final settlement price for a physically-delivered contract, we will look at how the actual delivery works.
In our example the short would deposit the notional value of 62,500 pounds per contract with an approved agent bank. The long position would have 1.2400 times 62,500, or $77,500, per contract deposited in an acceptable delivery bank.
The two banks agree to these terms per CME Group arrangement and cash versus currency are exchanged over the bank wire. All of this is completed by 10:00 a.m. CT on the settlement day, which is the third Wednesday of the contract month, two business days after last trading day.
For cash-settled FX futures, the process is much simpler. The final settlement price is determined by the clearinghouse. Any profit or loss is calculated by taking the difference between the final settlement price and the previous day’s mark-to-market
Like any other futures contract, a trader with an open position they may decide to offset or roll forward their position to avoid expiration and delivery. However, if they decide to go to expiration, they should understand the final settlement procedures for the specific contract they are trading.
Peter Knight Advisor