Cheapest to deliver is a futures contract approach where sellers can substitute underlying assets to reduce delivery costs, potentially decreasing the contract’s value. Buyers can secure assets at set prices, but may receive lower quality assets upon contract expiration.
“Cheaper to deliver” refers to an approach for some types of futures contracts where people can trade underlying securities on the delivery date to reduce the cost of delivery. If this is an option available to the contract seller, the contract price will generally be adjusted to reflect this, as there is a possibility that the seller will use less valuable underlying collateral, making the contract less valuable. The cheapest to deliver clause is clearly spelled out in the terms of the contract so that people have the opportunity to decide if they want to invest in it.
In a futures contract, the seller agrees to provide a set number of shares of an underlying asset at a set price on a particular delivery date. The buyer purchasing the contract reserves the right to purchase those assets at stated prices, possibly securing a better price than might be available on the open market at the time. This is a form of financial speculation, with people depending on fluctuations in value to make money.
In a cheapest-to-deliver contract, the seller can substitute other types of underlying assets when the contract expires and the buyer can exercise it. People may do this because switching assets is less expensive, because they cannot access a promised asset, or for other reasons. The buyer must accept the replacement according to the terms of the contract. Substituting assets of different grades into a cheaper contract to deliver may result in decreased value, as lower-rated assets are less stable and reliable and may not generate as much in terms of return.
When people write futures contracts, they consider all the available terms and develop a contract that suits their needs. Buyers can review a variety of contracts to see which one they like best, looking at both the prices of various contracts and the stated terms. If a seller can’t find a buyer for a contract, they may need to adjust to make it more attractive to other investors. The process of buying, selling and exchanging contracts happens all the time, in a variety of markets.
Cheapest to deliver offers a number of advantages to sellers. They can earn money from the contract and have the potential to earn more on the delivery date by being able to substitute the underlying securities. For buyers, it is a riskier investment decision, as there is a chance of receiving low-quality underlying assets when the contract expires.
Smart Asset.
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