Physical Delivery

Understanding Physical Delivery in Trading

When it comes to trading, you often hear the term Physical Delivery. But what does it mean? Physical Delivery is a term used in futures contracts trading. It refers to the actual transfer of the underlying asset when the contract expires. Whether it's precious metals, commodities, or currencies, you receive them in physical form.

The Process of Physical Delivery

The process of Physical Delivery starts when a futures contract reaches its expiry date. At this point, the buyer is obligated to take delivery and the seller to give delivery of the asset involved. This might seem confusing to beginners but in real life buying and selling commodities happen the same way. The only difference, it's all happening in the context of a future contract in trading.

Physical Delivery Vs. Cash Settlement

Now, you might ask, is Physical Delivery the sole method in futures trading? The answer is no. There's another method called cash settlement. In a cash settlement, instead of the actual underlying asset, cash equivalent to the market price of the asset is exchanged. This highlights a distinct difference between cash settlement and Physical Delivery.

The Role of Physical Delivery

Why is Physical Delivery important? It's pretty straightforward. Physical Delivery ensures that futures prices align with the prices of their underlying assets at the time of contract expiry. If there's a discrepancy, one can buy the contract, take Physical Delivery, and sell the asset at the higher spot price, thus creating arbitrage.

Pros and Cons of Physical Delivery

Like every other element of trading, Physical Delivery too has its pros and cons. The main benefit lies in the fact that it provides the opportunity to gain control over large quantities of the asset. This can potentially lead to price advantages. The downside? Physical Delivery implies dealing with the actual asset different from digital securities or indexes. This means dealing with storage, insurance, and transport issues for the asset.

Conclusion

Understanding Physical Delivery helps traders decide if this route is the best to take in the context of the contracts they hold or propose to hold. It allows one to consider the potential costs and benefits linked to the trade and make an informed choice.