Delivery Instrument Definition (original) (raw)
What Is a Delivery Instrument?
A delivery instrument is a contractual document that is traded as part of a commodity futures contract. It entitles the holder to physical delivery of a specified quantity of the commodity in question, such as soybeans in the case of soybean futures contracts.
Delivery instruments are an important part of the commodity futures trading system, because they can be easily transferred between different owners of the futures contracts. This makes it possible for traders to buy and sell futures easily, without ever necessarily intending to take physical possession of their underlying commodities.
Key Takeaways
- A delivery instrument is a legal document entitling the holder to receive the delivery of a specified amount of a commodity.
- It is transferred as part of a commodity futures contract, changing hands with each new owner.
- Speculators will generally not take delivery of the commodities underlying their futures contracts, meaning that a given batch of a commodity might change hands legally several times before being physically received by a buyer.
How Delivery Instruments Work
The commodity futures markets today are a large and vibrant marketplace in which industrial customers, speculators, and intermediaries regularly trade a wide variety of physical commodities. Through organized exchanges such as the Chicago Mercantile Exchange (CME), market participants regularly trade billions of dollars’ worth of energy products, agricultural commodities, and financial instruments, with new commodities being added on an ongoing basis.
One of the key pillars of these commodities markets is the participation of financial speculators. These traders regularly buy and sell futures contracts, hoping to profit from correctly predicting the future direction of commodity prices. But unlike industrial customers who rely on these commodities for their regular business operations, speculators have no intention of either making or receiving delivery of the commodities they trade.
Although their involvement may seem strange at first glance, speculators are an important part of the financial-market ecosystem because of the liquidity they provide. Because of this liquidity, other market participants who do deliver and receive the physical commodities can benefit from more efficient pricing for their trades.
Delivery instruments are key to participation of speculators. By allowing traders to easily transfer the right to receive physical delivery, speculators can quickly release themselves from the obligation to make or receive delivery by selling their futures contracts—and with it, the delivery instrument—to another buyer.
Delivery instruments often take the form of a shipping receipt or a receipt from a warehouse holding the commodity.
Real-World Example of a Delivery Instrument
To illustrate, consider the case of soybean futures. Three of the key parties involved in the soybean futures market are the companies that need to buy physical soybeans for their business operations, the speculators who buy and sell soybean futures contracts without intending to take delivery of them, and the companies that store and ship the soybeans to whichever party ultimately takes delivery of them.
In the CME market for Soybean Futures, one contract entitles the buyer to 5,000 bushels of soybeans. At a weight of roughly 136 metric tons, it is not surprising that most speculators would be quite reluctant to accept physical delivery of these soybeans. Therefore, it is entirely possible that a group of speculators could exchange soybean futures contracts among themselves several times, without any of them ever taking delivery of the underlying commodity. In that situation, the warehouse company in which the soybeans are stored would leave the soybeans untouched.
In this manner, it is entirely possible for a batch of soybeans to legally change hands several times through speculators buying and selling its futures contracts before an industrial customer eventually purchases them and has them delivered to its factory. Throughout this process, the delivery instrument would be regularly changing hands but would only be exercised at the end by the customer taking delivery.