Grains or Oilseeds futures contracts represent a commitment to make or take delivery of the commodity at some point in the future. To avoid delivery, you need to offset or roll forward your futures positions before a contract goes into its delivery cycle. Most futures positions are offset or rolled forward, and only a small percentage of them are actually held for delivery.
Even though most participants in the futures market will never be involved in actual delivery, it is important for all traders to understand the delivery process, due to the impact on futures contract pricing.
As the delivery month of a futures contract approaches, the cash price and futures price converge.. In many cases the cash and futures prices may be nearly the same. Although most futures positions are not held to delivery, it is the possibility of delivery that causes the cash and futures prices to converge.
Delivery of a Futures Contract
As a futures contract nears its delivery month, those who are still holding open futures positions are notified by their Futures Commission Merchant (FCM) or broker that they must either close out their positions or be prepared to go through the delivery process, which is facilitated by CME Clearing.
A short position holder must be prepared to deliver the underlying commodity. The delivery instrument for Grain and Oilseed futures is either a shipping certificate or a warehouse receipt. Only warehouses approved by the exchange can register and deliver these certificates or receipts. Therefore, a short position holder looking to deliver must be an approved warehouse or already own a certificate or receipt previously registered by an approved warehouse.
A long position holder must be prepared to take delivery of the commodity and pay the full value of the underlying futures contract. The long position holder receives either a warehouse receipt or a shipping certificate which entitles them to obtain the physical commodity from an approved warehouse.
The delivery for the different Grain and Oilseed futures contracts follow a three-day delivery process.
DAY 1 (POSITION DAY)
The first day of this delivery process is called position day. This is the day that the short position holder in the market indicates to CME Clearing that he intends to make delivery
on his futures position and registers a shipping certificate in the CME Clearing delivery system. Also, starting on the first position day, each FCM must report all of their open long positions to CME Clearing.
CME Clearing ranks the long positions according to the amount of time they have been open and assigns the oldest long position to the short position holder that has given his intention to deliver.
DAY 2 (NOTICE DAY)
On Day two, which is called notice day, the short position holder and long position holder receive notification that they have been matched, and the long position holder receives an invoice from CME Clearing.
DAY 3 (DELIVERY DAY)
Day three is the actual delivery day. The long position holder makes payment to CME Clearing, and CME Clearing simultaneously transfers the payment from the long to the short position holder, and transfers the shipping certificate from the short to the long position holder. Now the long position holder is the owner of the shipping certificate and he has several choices.
He can hold the certificate indefinitely, but must pay the warehouse that issued the certificate storage charges, which are collected and distributed monthly by CME Clearing.
He can cancel the shipping certificate and order the issuing warehouse to load-out the physical grain into a conveyance that he places at the issuing warehouse. He can transfer or sell the certificate to someone else. Or he can go back into the futures market and open a new position by selling futures, in which case he now becomes the short position holder.
He can then initiate a new three-day delivery process, which would entail re-delivery of the warehouse certificate he now owns. Note that he will continue to pay storage charges to the warehouse until he actually re-delivers the certificate.
Delivery is serious business. CBOT Rulebook chapter seven, available on cmegroup.com, is the definitive source on how this process works.
Now that you have an idea of how physical delivery works for Grain and Oilseed products, you will have a better understanding of its impact on futures prices as you plan your own futures trading strategies.
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