Physical Vs Cash Settlement Handling

When to Use

Use this skill on a position in an expiring contract, to answer three questions: what does this contract oblige the account to do, by when, and can the account do it?

The obligations are asymmetric in the position's direction, and that asymmetry is the whole point of the skill:

CME Clearing's delivery process is initiated by the short: it registers a shipping certificate, and CME Clearing ranks open long positions by age and assigns the oldest long. The long then "makes payment to CME Clearing, and CME Clearing simultaneously transfers the payment from the long to the short position holder and transfers the shipping certificate from the short to the long."

When NOT to Use

• As a calendar. The day counts are business-day numbers you supply. The engine does not know exchange holidays, the delivery calendar, or your broker's close-out deadline — and the broker's deadline, not the exchange's first notice day, is what binds a customer account.
• As reference data. settlement_type, multiplier and strike_price are contract terms you must source. Getting settlement_type wrong is the one input error this engine cannot detect.
• As an exercise or assignment model. Whether an expiring option is exercised at all — including a holder's contrary exercise advice against the OCC exercise-by-exception default — belongs to options-pin-risk-management-at-expiry. This skill prices and funds the delivery that an exercise produces.
• As a full delivery cost model. Invoice amounts here are the deliverable's principal only. Grade and location differentials, storage, demurrage and load-out charges are contract-specific and are not modelled.
• As a roll optimiser. It says close or roll by this date, not which contract month to roll into or how to execute the spread — see futures-contract-roll-automation.

Prerequisites

• Contract terms: symbol, settlement_type (CASH/PHYSICAL), instrument_kind (FUTURE/OPTION), multiplier in deliverable units per contract (1,000 barrels for CL; 100 shares for a standard US equity option), strike_price for a physically settled option.
• Both delivery clocks, as separate business-day counts: business_days_to_first_notice and business_days_to_last_trading_day. They are separate fields because they are different dates in a contract-specific order — for COMEX Gold, first notice day is the last business day of the month prior to the delivery month and last trading day is the third-last business day of it, so first notice day falls weeks earlier; for NYMEX WTI, trading terminates before the delivery month opens at all. Negative values mean the date has passed. Only the clock binding your side is required.
• Position state: position_qty (signed), entry_price, account_cash_balance, has_delivery_facility, deliverable_units_available (short side), prior_settlement_price.
• Close-out policy: SettlementPolicyConfig. Defaults to 2 business days for each side, mirroring IBKR's published futures close-out policy. That is a broker house rule, not a regulatory constant — set your own broker's.

Workflow

1. Classify the contract. CASH or PHYSICAL, FUTURE or OPTION.
   • Decision point — an unrecognised code is not a default. A vendor string the engine does not understand raises ValueError rather than falling through to either branch. Treating an unmapped code as physical invents a delivery obligation; treating it as cash hides one.
2. Compute the two cashflows, and report both.
   • $\text{FinalVariation} = Q \cdot M \cdot (P_{\text{settle}} - P_{\text{prior settle}})$
   • $\text{LifetimePnL} = Q \cdot M \cdot (P_{\text{settle}} - P_{\text{entry}})$
   • Decision point — these are not the same number. A futures position is marked to market daily, so the money that moves at expiry is the final variation margin; the move against entry is the lifetime result, most of which has already been paid or collected. Without prior_settlement_price the engine reports lifetime PnL and flags NO_PRIOR_SETTLEMENT_PRICE_LIFETIME_PNL_ONLY rather than silently conflating them.
3. Cash-settled branch. No deliverable — but not no risk.
   • The final settlement price is frequently a value that never printed in the regular session: CME's E-mini S&P 500 settles to a Special Opening Quotation built from the component stocks' opening prices on the third Friday, regardless of when those stocks open. Until the exchange publishes it, the report carries PROVISIONAL_SETTLEMENT_PRICE.
   • An adverse settlement is a funding event: if the debit exceeds the balance, status is CASH_SETTLEMENT_FUNDING_SHORTFALL.
4. Physical branch — resolve by direction.
   • Long $\implies$ TAKE_DELIVERY_AND_PAY, clock = first notice day, $V_{\text{invoice}} = |Q| \cdot M \cdot P_{\text{delivery}}$, provisioned iff has_delivery_facility and cash $\ge V_{\text{invoice}}$.
   • Short $\implies$ MAKE_DELIVERY_OF_UNDERLYING, clock = last trading day, units required $= |Q| \cdot M$, provisioned iff has_delivery_facility and deliverable_units_available $\ge$ units required. The invoice is $0$: a short is paid, and cash does not discharge a delivery obligation.
   • Decision point — $P_{\text{delivery}}$ is not always the settlement price. A futures delivery is invoiced off the final settlement price; an exercised physically settled option delivers against the strike. Pricing an option's delivery at spot understates the funding requirement by exactly the intrinsic value — it is most wrong when the option is deepest in the money.
   • Decision point — a missing clock is not a pass. If the day count binding this side is None, the engine raises rather than reporting a delivery obligation as compliant on an unknown clock.
5. Grade against the close-out buffer.
   • Past the deadline $\implies$ PHYSICAL_DELIVERY_DEADLINE_PASSED, ESCALATE_TO_DELIVERY_OPERATIONS. A roll no longer avoids the obligation — for a long, notices may already have been assigned.
   • Unprovisioned and inside the buffer $\implies$ PHYSICAL_DELIVERY_RISK_BREACH, CLOSE_OR_ROLL_BEFORE_DEADLINE.
   • Unprovisioned with time remaining $\implies$ PHYSICAL_DELIVERY_NOT_PROVISIONED — same action, raised early rather than at T-2.
   • A flat position reports FLAT_NO_OBLIGATION regardless of contract terms, never a breach against a zero-unit obligation.
6. Aggregate across the book (audit_portfolio_settlement). Per-position funding checks are individually satisfiable and collectively false: three long deliveries each pass cash >= invoice against the same balance while their sum overdraws it.

Full procedure: see references/workflows.md. Standards reference: see references/standards.md. Printable pre-flight checklist: see assets/checklist.md.

Common Pitfalls

• Testing a short position for cash. A short discharges its obligation by delivering a registered warehouse receipt or shipping certificate. A cash-rich short with no deliverable is in breach; a zero-cash short holding the certificate is fine. A cash >= notional test applied to both sides gets both of those backwards.
• Treating first notice day as everyone's deadline. It is the date from which a long can be assigned. A short is bound by last trading day, which for COMEX Gold is weeks later and for NYMEX WTI is earlier than the delivery period. One day count cannot express both.
• Assuming first notice day follows last trading day. For COMEX Gold it precedes it, so a long can be assigned a delivery notice while the contract is still actively trading — the position being liquid is not evidence that delivery is still avoidable.
• Rolling after the deadline. Selling the front month once notices are assigned leaves the delivery obligation in place and adds a new short. Past the deadline the problem belongs to delivery operations, not to the trading desk.
• Funding an option exercise at spot. An exercised call delivers shares against the strike. A 10-lot $100 call settling at $130 needs $100,000, not the $130,000 a spot-priced notional suggests — and the resulting stock trade settles T+1 (SEC Rule 15c6-1 as amended, effective 28 May 2024), so the cash is due the next business day.
• Reading "cash-settled" as "no expiry risk". The settlement value is determined by a special procedure, not by the last regular-session trade. A position marked at the 4:00 p.m. print and settled at the next morning's Special Opening Quotation is marked at the wrong number, and a large adverse settlement is a real margin call.
• Reporting lifetime PnL as the settlement cashflow. Daily mark-to-market means most of it has already moved. Sizing an expiry-day funding need off the move against entry price overstates it for a winner and understates it for a loser.
• Treating any non-CASH string as physical. A typo or an unmapped vendor code becomes a fabricated delivery obligation — or, worse in the other direction, silences a real one.
• Checking funding one position at a time. Three CL deliveries at $350,000 each pass individually against a $400,000 balance and need $1,050,000 together.
• Feeding gross legs instead of the net position. A long and a short in the same contract and the same account net to a flat position and no delivery obligation. Passed as two rows, they report a funded delivery and a deliverable requirement, and the aggregate invoice double-counts. Net by account and contract before calling.
• Rejecting a negative settlement price. NYMEX WTI settled at -$37.63 on 20 April 2020, driven by longs who could not take delivery at Cushing — the exact failure this skill screens for. Prices here must be finite but may be negative or zero; a validator that demands positive prices refuses the one event it most needs to model. Note what a negative invoice means: the long is paid to take delivery, so the cash test passes trivially and has_delivery_facility becomes the only thing standing between the account and the barrels.
• Trusting the 2-day default buffer. It mirrors one broker's published policy. Deadlines differ by broker and by product, and brokers may liquidate without further notification once they pass. Look yours up.

Verification

• Instantiate PhysicalVsCashSettlementHandlingEngine().
• Cash: 10 ES (multiplier 50) entered at 5000, prior settle 5040, settling at 5050 $\implies$ lifetime_pnl == 25_000.0 but final_variation_cashflow == 5_000.0, delivery_obligation == "NONE", binding_deadline == "NONE". Short 10 from a 4900 prior settle into 5050 with $50,000 cash $\implies$ CASH_SETTLEMENT_FUNDING_SHORTFALL on a $75,000 debit, flagged INSUFFICIENT_CASH_FOR_SETTLEMENT_DEBIT (not the delivery-invoice flag — a cash-settled contract has no invoice).
• Long physical: 5 CL (multiplier 1,000) at $70 $\implies$ delivery_invoice_usd == 350_000.0, binding_deadline == "FIRST_NOTICE_DATE", deliverable_units_required == 0.0.
• Short physical: the same 5 CL short with $0 cash but 5,000 barrels available $\implies$ MAKE_DELIVERY_OF_UNDERLYING, delivery_invoice_usd == 0.0, binding_deadline == "LAST_TRADING_DAY", not a breach. Flip it to $10m cash and 0 barrels $\implies$ PHYSICAL_DELIVERY_RISK_BREACH.
• Split clocks: first notice in 1 day, last trading day in 20. The long reports PHYSICAL_DELIVERY_RISK_BREACH; the short, same contract, same provisioning, reports PHYSICAL_DELIVERY_NOT_PROVISIONED.
• Boundary: with the default 2-day buffer, first notice in 2 days breaches and in 3 days does not; at -1 days, PHYSICAL_DELIVERY_DEADLINE_PASSED and ESCALATE_TO_DELIVERY_OPERATIONS.
• Option: 10 physically settled $100 calls (multiplier 100) settling at $130 against $110,000 cash $\implies$ delivery_price_basis == "STRIKE_PRICE", delivery_invoice_usd == 100_000.0, provisioned. A spot-priced invoice would have been $130,000 and would have failed.
• Flat: position_qty=0 on a physical contract with no delivery facility and first notice in 1 day $\implies$ FLAT_NO_OBLIGATION, NO_ACTION.
• Negative price: long 1 CL entered at $20 settling at -$37.63 $\implies$ accepted, lifetime_pnl == -57_630.0, delivery_invoice_usd == -37_630.0, no cash warning — but NO_DELIVERY_FACILITY still yields PHYSICAL_DELIVERY_RISK_BREACH.
• Negative checks: unrecognised settlement_type, a physically settled option with no strike_price, a missing binding day count, fractional day counts, non-finite (NaN/±inf) prices, non-positive multiplier or strike, and negative close-out buffers must each raise ValueError. Negative and zero prices must not.
• Portfolio: three long CL deliveries against a $400,000 balance $\implies$ every position PHYSICAL_DELIVERY_PROVISIONED but aggregate_delivery_invoice_usd == 1_050_000.0 and AGGREGATE_DELIVERY_INVOICE_EXCEEDS_CASH.
• Run python -m unittest discover -s skills/physical-vs-cash-settlement-handling/scripts.

Related Skills

• options-pin-risk-management-at-expiry
• futures-contract-roll-automation
• early-exercise-assignment-risk-management
• american-vs-european-style-option-exercise-handling
• margin-utilization-circuit-breaker