Delivery month

What Is Delivery Month?

The delivery month refers to the specific calendar month in which a futures contract is scheduled to expire, and the underlying asset must be delivered or settled. This crucial component of a futures contract falls under the broader category of Futures Markets, dictating when the obligations of buyers and sellers come due. For contracts that specify physical delivery, the delivery month is when the seller is obligated to provide, and the buyer is obligated to receive, the actual commodity or financial instrument. In contrast, for contracts that utilize cash settlement, the delivery month marks the final valuation or "mark-to-market" for the contract.

History and Origin

The concept of a delivery month is intrinsically linked to the evolution of organized futures trading, which emerged to bring order and efficiency to agricultural commerce. In the mid-19th century United States, unpredictable harvests and disorganized markets led to significant price volatility for agricultural products. To address these challenges, merchants and producers in Chicago formed the Chicago Board of Trade (CBOT) in 1848, initially as a cash market for grain. The CBOT soon began formalizing "to-arrive" agreements, which were early forms of forward contracts, allowing parties to agree on a price for future delivery.¹⁵,¹⁴,¹³

By 1865, the CBOT introduced standardized futures contracts, which included specific terms such as quantity, quality, and crucially, a standardized delivery month.¹²,¹¹,,¹⁰ This standardization streamlined trading and reduced negotiation time, laying the groundwork for the modern futures markets we see today, encompassing a wide range of financial derivatives beyond just agricultural commodities. The fixed delivery month provided certainty, allowing farmers to lock in prices for future crops and buyers to secure future supply, thereby facilitating risk management through hedging.

Key Takeaways

• The delivery month is the stipulated month for a futures contract's expiration and fulfillment of obligations.
• For physical delivery contracts, it's when the underlying asset changes hands; for cash-settled contracts, it's the final valuation period.
• It is a fundamental characteristic that allows for the standardization and liquidity of exchange-traded derivatives.
• While a delivery month is set, most futures contracts are offset before actual delivery or final settlement occurs.
• The selection of specific delivery months for various contracts is determined by the respective exchanges to align with commercial practices and market needs.

Interpreting the Delivery Month

The delivery month is central to how futures contracts are interpreted and traded. Traders and investors closely monitor different delivery months to understand market expectations for future prices. For instance, in commodity futures, if contracts for a nearer delivery month are trading at a higher price than those for a later delivery month (a situation known as "backwardation"), it might suggest a current supply shortage or strong immediate demand for the underlying commodity. Conversely, if later delivery months are priced higher ("contango"), it could indicate expectations of future oversupply or storage costs being factored into the price.

The choice of which delivery month to trade often depends on a participant's objective. Hedgers might choose a delivery month that aligns with their future production or consumption needs, while speculators often focus on the most active "front month" contracts, which tend to have the highest liquidity. Understanding the delivery month is also critical for assessing the basis, which is the difference between the spot price of the underlying asset and the futures contract price for a given delivery month.

Hypothetical Example

Consider a hypothetical scenario involving corn futures contracts on an exchange. Suppose it is currently July, and a farmer wants to hedge against a potential drop in corn prices for the upcoming harvest in October. The farmer might sell October corn futures contracts.

• Contract: Corn Futures
• Current Month: July
• Delivery Month: October

The farmer enters into a short position by selling October corn futures contracts. If, by October, the spot price of corn has indeed fallen, the farmer's loss on the physical corn harvest would be offset by a gain on their futures position (as they can buy back the futures contracts at a lower price to close their position). Conversely, if corn prices rise, the farmer benefits from the higher price for their physical corn, while incurring a loss on the futures contract, effectively locking in a price close to their original expectation. Most participants in this example would offset their positions before the actual delivery period within the delivery month.

Practical Applications

The delivery month is fundamental across various practical applications within financial markets:

1. Risk Management: Companies use futures contracts with specific delivery months to manage price risk for future purchases or sales of commodities, currencies, or interest rates. For example, an airline might buy jet fuel futures contracts for a future delivery month to lock in a price for their fuel needs, protecting against rising costs. This is a classic example of hedging.
2. Price Discovery: The prices of futures contracts across different delivery months reflect market expectations for future supply and demand conditions, aiding in price discovery for the underlying assets. Financial media outlets like the Financial Times regularly publish commodity futures prices across various delivery months, offering insight into market sentiment.⁹
3. Speculation: Speculators analyze price movements between different delivery months to profit from anticipated changes in market conditions. They may take long positions if they expect prices to rise or short positions if they expect prices to fall, typically closing out their positions before the delivery period.
4. Regulatory Compliance: Regulatory bodies, such as the Commodity Futures Trading Commission (CFTC) in the U.S., define strict rules around the delivery process within the delivery month to ensure fair and orderly markets and prevent manipulation. The CFTC provides guidance on what constitutes "actual delivery" to differentiate legitimate transactions from prohibited off-exchange retail commodity agreements.⁸

Limitations and Criticisms

While the delivery month provides structure to futures contracts, certain limitations and criticisms exist, primarily concerning the potential for market manipulation or delivery-related complexities.

One significant concern is the potential for market "squeezes" or "corners" near the delivery month. This occurs when a single entity acquires a dominant long position in futures contracts and simultaneously controls a significant portion of the available supply of the underlying physical commodity. As the delivery month approaches, those with short positions who need to deliver the commodity find it difficult or impossible to acquire the physical asset, forcing them to buy back their futures contracts at artificially inflated prices from the manipulator. The "Silver Thursday" incident in 1980, involving the Hunt brothers' attempt to corner the silver market by taking massive physical delivery of silver, serves as a notable historical example of such a squeeze impacting the market.⁷,,⁶ Academic research has analyzed conditions under which such manipulation of the delivery_month process is most likely to occur.⁵,⁴

Another limitation stems from the practicalities of physical delivery. While the intent of physical delivery is to ensure convergence between futures and spot price, the costs and logistical complexities associated with taking or making delivery (such as storage, transportation, and quality grading) mean that very few futures contracts actually result in physical delivery.³,² This can sometimes lead to basis distortions if the costs of delivery or the available supply at approved delivery locations do not align with market expectations.

Furthermore, discrepancies in how exchanges define acceptable delivery locations or grades can create challenges for market participants, requiring careful attention to contract specifications. The reliance on the clearing house to manage the delivery process helps mitigate counterparty risk, but the underlying complexities of fulfilling obligations within the delivery month remain a critical consideration.

Delivery Month vs. Expiration Date

While closely related, the delivery month and the expiration date in futures contracts are distinct concepts.

• Delivery Month: This refers to the calendar month in which the contract's obligations are due to be fulfilled. It broadly defines the period for settlement or delivery. For example, a "December crude oil contract" refers to a contract with December as its delivery month.
• Expiration Date: This is the precise date within the delivery month (or sometimes, the month preceding the delivery month) on which trading in the particular futures contract ceases. After the expiration date, no new trades can be initiated for that specific contract. The final settlement or delivery procedures typically commence shortly after or on the expiration date and continue until the end of the delivery month.

Essentially, the expiration date marks the end of active trading for a specific contract, while the delivery month encompasses the entire period during which the physical delivery or cash settlement of the underlying asset must occur according to the exchange's rules. Most speculators and arbitrageurs close their positions before the expiration date to avoid the complexities of delivery or settlement.

FAQs

1. Are all futures contracts physically delivered in their delivery month?

No, not all futures contracts involve physical delivery. Many are settled via cash settlement, where the final profit or loss is determined by the difference between the contract price and a reference price (e.g., the spot price of the underlying asset) on the expiration date within the delivery month. Even for contracts that allow for physical delivery, the vast majority are offset before the delivery period.¹

2. How are specific delivery months chosen for futures contracts?

Futures exchanges, such as those under CME Group, select specific delivery months based on the underlying asset's commercial practices, seasonality, and market liquidity. For instance, agricultural commodity futures often have delivery months aligned with harvest cycles, while financial futures (like interest rate or index futures) may align with quarterly cycles.

3. What happens if I hold a futures contract until its delivery month?

If you hold a long position in a physically deliverable futures contract until the delivery month, you will be obligated to take possession of the underlying commodity or financial instrument. If you hold a short position, you will be obligated to deliver the underlying asset. Traders typically close out their positions before the delivery period to avoid these obligations, unless they intend to take or make actual delivery. The clearing house facilitates this process.

4. Can the delivery month be changed after a contract is purchased?

No, the designated delivery month is a fixed term of the futures contract and cannot be changed by individual traders after the contract is purchased. However, traders can roll their position to a different delivery month by simultaneously selling their current contract and buying a contract for a later delivery month.

5. What is the significance of the "front month" in futures trading?

The "front month" refers to the futures contract with the nearest delivery month. It is often the most actively traded contract and usually reflects the most current market sentiment and spot price expectations. Its liquidity makes it attractive for speculators and for analyzing short-term price dynamics.