CashSettlement

Cash settlement is a method of closing a financial contract by paying cash, rather than delivering the underlying asset. It is commonly used for derivatives such as futures and options, as well as certain over-the-counter products and index-linked instruments. The cash amount paid at settlement reflects the difference between the contract’s agreed price and the specified reference price at expiration, adjusted for the contract size or multiplier.

In practice, settlement typically follows a defined process. For futures, the final settlement price is determined by the exchange or a designated mechanism, and the holder of a position receives or pays cash equal to the price difference times the contract’s multiplier. Daily mark-to-market may continue to adjust gains and losses throughout the contract’s life, with final cash settlement occurring on expiration or a settlement date. For options, cash settlement may occur when exercising a contract on an index or other non-deliverable instrument, with the payoff representing the intrinsic value expressed in cash. Some contracts can also be cash-settled even when the underlying asset could be delivered physically, depending on the contract terms.

Cash settlement is common for index futures and options on indices, certain commodity futures, and many over-the-counter derivatives. It eliminates the need for physical delivery, simplifies logistics, and can reduce storage and transportation costs, but it can also result in large, potentially volatile cash flows and reliance on a robust price settlement mechanism and clearinghouse risk management.

Regulatory and market infrastructure support for cash settlement includes standardized contract terms, settlement price definitions, and margin requirements administered by exchanges and clearinghouses to manage counterparty risk.