What Is First Notice Day?
First notice day is a critical date in the lifecycle of a futures contract, marking the point when the holder of a short position in a physically delivered commodity or financial futures contract can officially inform the corresponding futures exchange of their intent to deliver the underlying asset. This date is part of the broader derivatives market framework. It signifies the commencement of the delivery process, obligating the holder of a long position to accept physical delivery if they still hold the contract by this point.
History and Origin
The concept of standardized delivery procedures in futures markets evolved alongside the formalization of commodity exchanges in the 19th century, particularly with the growth of agricultural markets. Early exchanges, such as the Chicago Board of Trade (CBOT) established in 1848, sought to bring order and efficiency to the trading of commodities like grain. The need for clear rules regarding the fulfillment of contracts, especially for physical delivery, led to the establishment of specific dates for initiating and completing the transfer of goods. These rules were crucial for ensuring market integrity and facilitating commerce across vast distances, providing mechanisms for sellers to declare their intent to deliver and buyers to prepare to receive, thereby reducing counterparty risk in an era before widespread electronic communication. The evolution of these practices has been integral to the functioning of modern futures markets.
Key Takeaways
- First notice day is the first date on which a short seller of a physically deliverable futures contract can give notice of their intention to deliver the underlying asset.
- For traders holding a long position, it signals that they may be assigned a delivery obligation.
- It is a significant date for managing futures positions, particularly for speculators who typically prefer to exit their trades before physical delivery obligations arise.
- The specifics of first notice day, including the exact date and the underlying procedures, vary by exchange and by the particular futures contract.
- Understanding this date is essential for preventing unintended physical delivery or its associated financial and logistical burdens.
Interpreting the First Notice Day
First notice day primarily indicates the transition from a purely financial trading instrument to a potential physical transaction. For participants who intend to take or make physical delivery of a commodity, this day is an important step in their supply chain or inventory management. However, for the vast majority of futures traders, especially those engaged in speculation or hedging without a direct interest in the physical asset, first notice day serves as a critical deadline. If a long position is held past this day, the trader risks being assigned a delivery obligation. Conversely, a short position held past this day might be required to make delivery. Most speculative traders close out their positions well before first notice day to avoid the complexities and costs associated with physical settlement.
Hypothetical Example
Consider an investor, Sarah, who holds a long position in a December crude oil futures contract. The contract specifies physical delivery. The first notice day for this December contract is November 30. Sarah's initial intention was to profit from price movements, not to take delivery of oil.
As November 30 approaches, Sarah realizes she still holds the long contract. On this day, a counterparty holding a short position could issue a notice of intent to deliver crude oil. If Sarah does not close her position by the end of the trading day on November 29, she would be obligated to accept delivery of 1,000 barrels of crude oil (the standard contract size) at a designated delivery point, likely incurring storage, transportation, and insurance costs. To avoid this, Sarah would typically liquidate her position before November 30, either by selling her long contract or by entering an offsetting short position, effectively canceling her exposure to physical delivery.
Practical Applications
First notice day is fundamentally relevant in markets dealing with physical settlement, such as those for agricultural products, metals, and energy. For example, a commercial bakery that uses wheat futures to hedge against price fluctuations might intentionally hold a long wheat futures contract past first notice day to take actual delivery of the grain for their operations. Similarly, an oil producer might maintain a short crude oil futures position into the delivery period to physically offload their production.
Conversely, financial institutions and individual traders who use futures for speculation or portfolio management, and who have no intention of handling physical goods, will actively monitor first notice day. For these participants, failure to close out a position before this date can lead to unexpected and costly obligations related to physical receipt or delivery, potentially requiring significant capital and logistical arrangements outside their typical operations. Major exchanges, such as CME Group, provide detailed procedures for the delivery process for various commodities to ensure smooth transitions from futures contracts to physical goods. The Commodity Futures Trading Commission (CFTC) oversees these markets to ensure integrity and prevent manipulation, including rules related to delivery.
Limitations and Criticisms
While essential for the functioning of physically settled futures markets, first notice day and the associated delivery process can introduce complexities. For traders unfamiliar with the nuances of physical settlement, holding a position past first notice day can lead to unexpected logistical burdens and significant financial requirements beyond the initial margin account requirements. This can be particularly problematic for small-scale speculators who may not have the infrastructure to manage physical assets.
Furthermore, the process of physical delivery itself can sometimes be a point of market stress, especially if there are imbalances in supply or demand at the designated delivery points, or if the quality or form of the deliverable asset is ambiguous. Historical examples, such as stresses in certain commodity markets during periods of extreme volatility, have highlighted how the intricacies of physical delivery can exacerbate price movements and create liquidity challenges if a large number of participants are forced into or out of physical positions simultaneously. This underscores the importance of understanding the specific delivery rules of each futures contract and the potential implications of holding positions through first notice day.
First Notice Day vs. Last Trading Day
First notice day and last trading day are two distinct, yet related, dates in the futures contract cycle. First notice day is the initial day on which a short seller can declare their intent to make physical delivery of the underlying asset. If a long position holder maintains their contract past this date, they risk being assigned a delivery obligation. Conversely, the last trading day is the final day on which a particular futures contract can be bought or sold on the exchange. After the last trading day, all remaining open positions are settled, either through physical delivery (for physically settled contracts) or cash settlement (for cash settlement contracts). The confusion often arises because both dates represent deadlines for traders to manage their positions to avoid unintended outcomes, but first notice day always precedes or occurs on the same day as the last trading day, providing an earlier warning for physical delivery obligations.
FAQs
What happens if I hold a futures contract past first notice day?
If you hold a long futures contract past first notice day, you risk being assigned an obligation to take physical delivery of the underlying asset. This means you would need to arrange for payment, transportation, and storage of the commodity, which can be logistically and financially burdensome if you did not intend to take actual possession.
Is first notice day applicable to all futures contracts?
No, first notice day is only applicable to futures contracts that are settled via physical settlement. Contracts that use cash settlement, such as many stock index futures or interest rate futures, do not have a first notice day because no physical asset changes hands.
How can I avoid physical delivery of a futures contract?
To avoid physical delivery, you must close out your futures position before the first notice day. This is typically done by executing an offsetting trade—selling a long contract or buying back a short contract—which cancels your obligation. Traders often monitor the expiration date and associated delivery dates closely.
Does first notice day apply to options contracts?
First notice day generally does not apply directly to options contracts. Options holders have the right, but not the obligation, to exercise their options. If an option is exercised and leads to the creation of a futures position, that resulting futures position would then be subject to the first notice day of the underlying futures contract.
Where can I find the first notice day for a specific contract?
The first notice day, along with other critical dates like the last trading day and open interest information, is always specified in the contract specifications published by the respective futures exchange (e.g., CME Group, ICE Futures). These details are publicly available on the exchange's website.
Sources:
CME Group. "How Futures Trading Began." https://www.cmegroup.com/education/articles-and-reports/how-futures-trading-began.html
CME Group. "Understanding the Delivery Process for Agricultural Futures." https://www.cmegroup.com/education/articles-and-reports/understanding-delivery-process-for-agricultural-futures.html
Reuters. "Global nickel crunch triggers extreme volatility on LME." https://www.reuters.com/markets/commodities/global-nickel-crunch-triggers-extreme-volatility-lme-2022-03-08/
Commodity Futures Trading Commission. "About the CFTC - What We Do." https://www.cftc.gov/About/WhatWeDo/index.htm