Physical Settlement

Physical settlement is the delivery of the underlying asset to the owner of an option or futures contract at the contract’s expiration date. For example, if two parties enter into a physically settled six-month gold futures contract at a futures price of $20.00, the buyer is obligated to purchase a specified amount of physical gold on the settlement date, regardless of the spot price of gold on that date. Often, traders will factor the cost of carry into the futures price. The cost of carry is any expenses for storing, shipping, and insuring the physical commodity over a period of time. Not all options or futures contracts are physically settled. Physical settlement is most common with commodities and bonds contracts, although it can occur with other financial instruments. Physical settlement is carried out by clearing brokers.