FRM Exam Part I · Futures Markets

Futures Delivery, Settlement and Order Types Explained

Updated 11 October 2026 · Fact-checked

Futures end in physical delivery of the asset or in cash settlement against a reference price. Before expiry, the futures price converges to the spot price. The short often chooses what, when and where to deliver, and that choice has value. Orders (market, limit, stop) control how you enter or exit.

Understand Delivery, Settlement and Order Types

A futures contract is a promise to buy or sell an asset at a set price on a set date. Most contracts never reach that date. Traders close them out by taking the opposite position. Only a small share ends in delivery. But the delivery rules matter, because they tie the futures price to the spot price.

Physical settlement means the short delivers the actual asset and the long pays the final settlement price. Commodity futures and Treasury bond futures work this way. Cash settlement means no asset moves. At expiry the contract is marked to the final reference price and the last margin flow settles the position. Stock index futures are the standard example, because delivering a whole index is impractical. Cash-settled futures are marked to the spot (index) price on the last day.

Convergence is the key idea. As expiry nears, the futures price and the spot price move together and are equal at expiry. If the futures price were above spot during the delivery period, an arbitrageur would buy the asset, short the future, deliver and lock in a profit. This pushes the futures price down. If it were below spot, arbitrageurs and others who plan to buy the asset would buy the future and take delivery, which is cheaper than buying spot. This pushes the futures price up. Either action pushes the prices back together. In practice, small gaps remain because of delivery costs and options.

The short usually holds delivery options. These include the choice of delivery day within the month, the delivery location, and the grade of asset. For Treasury bond futures the short picks which bond to deliver, which is the cheapest-to-deliver bond. It is the bond that minimises: quoted bond price − (settlement price × conversion factor). The short receives the futures settlement price × conversion factor plus accrued interest, and pays the quoted bond price plus accrued interest to buy the bond. Accrued interest cancels in the comparison, so you leave it out. Other options are the wild card option (giving notice after the futures market closes) and the end-of-month option. These options favour the short, so they push the futures price down.

Orders tell the broker how to trade. A market order executes at the best available price now. A limit order executes only at your price or better. A stop (stop-loss) order becomes a market order once the price touches the stop level. A stop-limit order becomes a limit order at that trigger. Others include market-if-touched, discretionary, time-of-day, open and fill-or-kill. Exchanges also set daily price limits: the maximum move from the prior settlement price. If the price hits the limit, trading can stop or continue only inside the limit.

Key formulas to remember

Convergence at expiry: Futures price at expiry = Spot price at expiry; Holds at delivery for the deliverable asset. Before expiry, the gap is the basis: spot − futures.
Basis: Basis = Spot price − Futures price; Basis tends toward zero as expiry approaches. Sign conventions vary, so read the question.
Cash settlement flow: Long gain = (Final settlement price − Previous settlement price) × contract size; Final day is marked to the reference price. Short gets the opposite.
Cheapest to deliver (T-bond): Cost to deliver = Quoted bond price − (Settlement futures price × Conversion factor); Choose the bond with the lowest value. The short receives the futures settlement price × conversion factor plus accrued interest, and pays the quoted price plus accrued interest, so accrued interest cancels in the comparison.
Cash received by short at delivery: Cash = (Settlement futures price × Conversion factor) + Accrued interest; Applies to Treasury bond futures delivery.
Daily price limit band: Limit range = Previous settlement ± Daily limit; Orders cannot trade outside the band on that day.

How to solve Delivery, Settlement and Order Types questions

Use this approach for any question on delivery, settlement or orders.

1Identify the contract: physical or cash-settled, and the underlying asset.
2Decide what the question tests: convergence, a delivery option, the cheapest-to-deliver bond or an order type.
3For convergence, check the time to expiry. At expiry, futures equals spot. Before it, use the basis.
4For delivery options, ask who holds the option. The short usually does, so it lowers the futures price.
5For cheapest to deliver, compute quoted price − (futures price × conversion factor) for each bond. Pick the lowest.
6For order questions, match the trigger and the execution: market is now, limit is price or better, stop triggers at the level.
7For price limits, compute the allowed band from the previous settlement and check whether the price can trade.
8Check the sign and units before choosing an answer.

Quickest way: Fast triage for settlement and order questions

When to use it: Use it when the question is conceptual or needs one short calculation and you have about two minutes.

Underline the key words: cash, physical, short, long, stop, limit, limit-up.
Recall the rule: index means cash settled, bond means delivery with a short option.
For cheapest to deliver, compute only the cost-to-deliver for each bond and take the minimum.
Remove options that give the long a delivery option or that claim futures and spot differ at expiry.
For orders, a stop to sell sits below the current price, a limit to sell sits above. A stop to buy sits above the current price, a limit to buy sits below.

Common mistakes in Delivery, Settlement and Order Types

Saying the long chooses which bond to deliver.
Students forget the short initiates delivery.
Fix: The short holds the delivery options. They lower the futures price.
Picking the bond with the lowest quoted price as cheapest to deliver.
Ignoring the conversion factor and futures price.
Fix: Compute quoted price − (futures price × conversion factor) for each bond. Choose the smallest.
Saying futures and spot are always equal before expiry.
Mixing up convergence with equality at all times.
Fix: They are equal only at expiry for the deliverable asset. Before that, basis can be nonzero.
Treating a stop order as a limit order.
Both set a price level.
Fix: A stop becomes a market order once triggered, so execution price can differ. A limit guarantees price but not execution.
Assuming cash settlement means no final margin flow.
No asset changes hands, so students think nothing settles.
Fix: The final mark-to-market is paid in cash against the reference price.
Thinking price limits cap the loss on a position.
Confusing a daily trading band with a loss limit.
Fix: Limits only restrict daily price moves. Losses can continue over later days.

Worked examples

Example 1

A Treasury bond futures settlement price is 120. Bond A is quoted at 130.00 with a conversion factor of 1.0800. Bond B is quoted at 145.50 with a conversion factor of 1.2000. Which is cheapest to deliver, and what is its cost?

Show the solution

Formula: cost = quoted price − (futures price × conversion factor).
Bond A: 120 × 1.0800 = 129.60. Cost = 130.00 − 129.60 = 0.40.
Bond B: 120 × 1.2000 = 144.00. Cost = 145.50 − 144.00 = 1.50.
The lowest cost is Bond A at 0.40.

Answer: Bond A is cheapest to deliver, with a cost of 0.40 per 100 face value.

Example 2

A stock index futures contract is cash settled with a multiplier of $250 per index point. You are long 4 contracts. The prior day settlement is 4,500.00 and the final settlement at expiry is 4,512.40. What is your final-day cash flow?

Show the solution

Gain per contract in points = 4,512.40 − 4,500.00 = 12.40.
Per contract in dollars = 12.40 × 250 = $3,100.
For 4 contracts = 3,100 × 4 = $12,400.
You are long and the index rose, so the flow is received.

Answer: You receive $12,400 on the final day, and no asset is delivered.

Exam tips

Know which contracts are cash settled (stock index) and which deliver (bonds, commodities).
In delivery-option questions, remember the short holds the options and they lower the futures price.
For cheapest to deliver, show the calculation for every bond. Differences can be small.
Match the order type to its trigger. Stop uses a trigger, limit sets a price bound.
If a question mentions limit-up or limit-down, think about the band and whether the market can trade.

Practice questions from Futures Markets

Delivery, Settlement and Order Types: frequently asked questions

What is the difference between physical and cash settlement?

Physical settlement means the short delivers the asset and the long pays the price. Cash settlement means the final gain or loss is paid in cash against a reference price. Index futures are cash settled because delivering the index is impractical.

Why does the futures price converge to the spot price?

At expiry the futures contract is a claim on immediate delivery of the asset, so its price must equal spot. If not, arbitrageurs buy the cheaper and sell the dearer and push the prices together.

What is the cheapest-to-deliver option?

It is the short's right to choose which eligible bond to deliver on a Treasury bond futures contract. The short picks the bond with the lowest quoted price − (futures price × conversion factor). Accrued interest is received by the short and paid by the long, so it cancels in this comparison. The option has value to the short and lowers the futures price.

How do limit, stop and market orders differ?

A market order executes now at the best available price. A limit order executes only at your price or better. A stop order becomes a market order once the stop level is touched, so execution price may differ from the stop.