Compulsory delivery
Also written Compulsory delivery contract · Compulsory delivery logic
A delivery logic under which every position still open at expiry must give or take physical delivery — neither side can elect to settle in cash.
In plain language
Most people who trade commodity futures never intend to see the commodity. On a compulsory delivery contract, intention is irrelevant.
If you are short at expiry, you deliver quality-certified goods of the contracted quantity. If you are long, you pay and you take them. There is no cash-settlement escape hatch, no matter how unwelcome a kilogram of gold or ten tonnes of mustard seed may be.
That is what keeps the futures price honest. A contract that can always be closed in cash can drift from the physical market; a contract that ends in real grain in a real warehouse cannot drift far, because somebody will arbitrage the gap by actually buying the grain.
How it works
The workbook lists three delivery logics — compulsory delivery, both options and cash settlement — and the contract specification names which one applies. Gold is a compulsory delivery contract.
Under compulsory delivery, both buyer and seller with an open position during the tender or delivery period are obligated to take or give delivery. In many such contracts the tender marking period begins well ahead of maturity. Any open interest surviving the expiry date is settled through physical delivery, full stop.
Three consequences follow, and each is examinable:
- Every compulsory delivery futures contract must have a staggered delivery period. Deliveries are spread rather than crammed into expiry day.
- Once the tender period opens, the contract trades like a cash market, not a futures market. A fresh long bought on day one of the tender period carries a real risk of being matched against a seller who has tagged a delivery intention.
- Failure to deliver is not free. The short who cannot produce the goods pays the delivery default penalty and compensates the buyer.
Open interest remaining on the settlement date is therefore read by the market as a direct forecast of how much commodity will actually move.
A worked example
Gold, one lot, held to expiry.
A speculator is short one gold futures contract — lot 1 kilogram — that he sold at Rs 49,600 per 10 grams. He forgets to square off. The Final Settlement Price is Rs 50,000 per 10 grams.
| Obligation | Amount |
|---|---|
| Value of the lot at FSP | Rs 50,00,000 |
| Plus GST on the tax-paid invoice he must raise | as applicable |
| Tender period margin already lodged, at 20% of contract value | Rs 10,00,000 |
He must now hand over one kilogram of quality-certified gold, evidenced by a warehouse receipt, into the clearing corporation's pay-in. He does not own a kilogram of gold.
His choices are two. Buy the metal in the physical market, deposit it, get it assayed, and deliver — which takes days he no longer has. Or default, and pay, on a non-agricultural commodity:
Penalty = 3% of settlement price + replacement cost
= 3% x 50,00,000 + replacement cost
= Rs 1,50,000 + replacement cost
of which Rs 87,500 (1.75%) goes to the Settlement Guarantee Fund, up to Rs 12,500 (0.25%) is retained by the clearing corporation, and Rs 50,000 (1%) plus the whole replacement cost goes to the buyer he let down.
Why NISM asks about it
Chapter 6 (Trading Mechanism), section 6.2.4 on delivery logic, and Chapter 7 (Clearing, Settlement and Risk Management), section 7.3.1. Expect "in compulsory delivery, both buyer and seller having an open position during the tender/delivery period are obligated to ____", and questions pairing compulsory delivery with the mandatory staggered delivery period.
Common exam traps
- Compulsory delivery is set by the contract, not chosen by the trader. It is a specification, like lot size.
- Both options is the logic where either side can refuse. Under compulsory delivery neither can.
- All compulsory delivery contracts must have a staggered delivery period. Cash-settled contracts do not.
- After the tender period opens, the contract behaves like a cash market. Taking a fresh position there is not the same trade it was a week earlier.
- Gold is compulsory delivery; index futures are not. Bullion being expensive does not make it cash settled.
- The exchange guarantees financial settlement, not gross delivery — a defaulted buyer gets compensation and the penalty share, not the commodity.
Check yourself
1.Under the staggered delivery mechanism, a buyer randomly assigned a delivery obligation by the exchange must take delivery:
- a)On the same day
- b)On the next day
- c)On the expiry date
- d)On T+2 day
Show the answer
Answer: (d) On T+2 day
(This is a sample question from the NISM workbook.)
"THE CORRESPONDING BUYER WILL BE RANDOMLY ALLOCATED by the trading system of the exchange, and THEY WILL HAVE TO TAKE THE DELIVERY ON THE T+2 DAY AT THE DESIGNATED DELIVERY CENTRE where the seller has delivered the commodity through TITLE TRANSFER OF OWNERSHIP OF PHYSICAL GOODS."
The purpose of the whole mechanism: "This is to ENSURE CONFIRMATION OF DELIVERY IN THE NEAR MONTH CONTRACT AND TO KEEP THE PRICE VOLATILITY UNDER CHECK."
Spreading deliveries over several days, rather than concentrating every obligation on expiry day, prevents a last-minute scramble in which anyone short of goods can be squeezed.
What changed recently: ⚠️ "SEBI via circular dated MAY 24, 2024 HAS REDUCED THE STAGGERED DELIVERY PERIOD to THREE DAYS FROM THE EARLIER FIVE DAYS." And "ALL COMPULSORY DELIVERY COMMODITY FUTURE CONTRACTS ARE REQUIRED TO HAVE A STAGGERED DELIVERY PERIOD."
The price used: "The settlement price for any delivery allocation during the staggered delivery period — i.e. UP TO ONE DAY PRIOR TO EXPIRY — WOULD BE THE LAST AVAILABLE SPOT PRICE DISPLAYED BY THE EXCHANGE." Note that it is a spot price, not the futures price, because at this stage the transaction really is a cash market transaction.
2.Under SEBI's circular dated 24 May 2024, what is the mandatory minimum staggered delivery period for a commodity futures contract settled by physical delivery?
- a)1 day
- b)2 days
- c)3 days
- d)5 days
Show the answer
Answer: (c) 3 days
Chapter 6's words: "In a change in the regulatory policy by SEBI Circular dated MAY 24, 2024, the MANDATORY MINIMUM OF 3 DAYS has been prescribed as the minimum number of days for staggered delivery of any given commodity."
Chapter 7 says the same thing: "SEBI via circular dt. May 24, 2024 has REDUCED THE STAGGERED DELIVERY PERIOD... TO THREE DAYS FROM THE EARLIER FIVE DAYS." So option (c) is right.
Why the others are wrong:
- (d) 5 days was the earlier period. The 2024 circular reduced it.
- (a) 1 day and (b) 2 days are below the prescribed minimum. Do not confuse them with the T+2 rule: a buyer who is randomly assigned delivery during the staggered period takes delivery "on the T+2 day". That rule is about when delivery happens, not how long the period lasts.
Who it applies to: "ALL COMPULSORY DELIVERY commodity future contracts are required to have a staggered delivery period." The staggered delivery period and the delivery period margin are both "specified for the commodities that are settled through the physical delivery-based final settlement."
3.A contract follows the 'both options' delivery logic. At expiry the buyer wants to take delivery, but the seller matched against him does not opt to give delivery. What happens to the open position?
- a)It is cash settled at the Due Date Rate
- b)The seller is compelled to deliver, as under compulsory delivery
- c)The seller is charged the delivery default penalty of 4% of the settlement price
- d)The position is rolled into the next month's contract
Show the answer
Answer: (a) It is cash settled at the Due Date Rate
The workbook's words: "In the case of a both options, the delivery will be executed ONLY WHEN BOTH BUYERS AND SELLERS AGREE to take/give delivery. EVEN IF ONE OF THEM in a trade DO NOT OPT FOR DELIVERY, such open positions are CASH SETTLED AT THE DUE DATE RATE (DDR)." So option (a) is right.
The three settlement options: "at present three settlement options are available to the buyer/seller: COMPULSORY DELIVERY, BOTH OPTIONS AND CASH SETTLEMENT."
Why the others are wrong:
- (b) describes compulsory delivery, where "both the buyer and seller with an open position during the tender/delivery [period]... are obligated to take/give delivery." Under 'both options' neither side can be forced.
- (c) The delivery default penalty applies when a seller who is obliged to deliver fails to do so. Here the seller had no such obligation, so there is no default.
- (d) Contracts are not rolled over automatically. Open positions at expiry are settled.
What the DDR is: the DDR (or FSP) "is usually the AVERAGE OF SPOT PRICES (POLLED) IN LAST FEW DAYS of Futures contract as defined per the contract specification". For electricity it is the volume weighted average of all the days in the expiring month; for other commodities it may be 3–5 days.
Where this is taught
Free preparation for NISM Series XVIRelated terms
- Final Settlement PriceThe price at which a commodity derivative is finally settled at expiry — a simple average of the polled spot prices of the expiry day and the two days before it.
- SettlementThe step where the obligations computed by clearing are actually discharged — commodities against funds on a delivery-versus-payment basis, or cash against the settlement price.
- Warehouse receiptA document of title issued by an exchange-accredited warehouse to whoever deposited goods in it, transferable by endorsement and deliverable against a short futures position.
- Both optionsA commodity futures settlement type in which physical delivery happens only if both the buyer and seller agree to it — if either declines, the open position is cash-settled at the Due Date Rate instead.
- Delivery default penaltyThe SEBI-prescribed charge on a seller who fails to deliver against an expiring contract — a fixed percentage of the settlement price plus a replacement cost, most of which is paid over to the buyer.
- Staggered delivery periodThe window before expiry in which buyers and sellers holding open positions may mark an intention to give or take delivery, spreading deliveries out instead of stacking them on expiry day.
- Tender period marginAn extra margin charged at client level on all open positions once a contract enters its tender or delivery period — the higher of 20% of contract value, or 3% plus a five-day 99% VaR of spot prices.
- Warehouse Service ProviderThe company accredited by a clearing corporation to store exchange-deliverable commodities — WDRA-registered for agricultural goods, capped at 33 times its net worth, and barred from trading in what it stores.
- Delivery notice periodA window, unique to commodity futures, in which a seller may give notice of intent to deliver — giving the buyer time to arrange finance, transport and warehouse logistics before physical delivery.
- Electricity futuresExchange-traded, cash-settled contracts that let participants lock in a price for round-the-clock electricity delivery over a month, up to three months ahead, without any physical delivery obligation.
- Financial futuresFutures on currency rates, interest rates (bond futures) and equity prices (stock or index futures) — grouped together in the workbook as distinct from commodity futures, and without a delivery notice period.
- Expiry-day square-off rightA member's right, not obligation, to leave a client's position open on the last day of a contract unless the client expressly asks for it to be squared off.
- StandardisationThe exchange fixing a futures contract's size, quality, delivery place, delivery date and permitted price moves, so strangers can trade the same contract on a public market.
- Inter-state delivery problemThe GST trap in exchange delivery — the exchange collects only CGST and SGST, so a buyer tagged to a seller in another state may be unable to claim credit without a registration for that state.
- Net obligation reportThe end-of-day report giving a trading member's net obligation, margin deposit, margin utilised, available deposit, the pay-in or pay-out required and the transaction fee payable or receivable.
- Physical stocks disclosureThe warehouse stock data an exchange discloses, showing how far open interest is actually backed by goods — low stocks suggest the positions will be squared off rather than delivered.
- Premium and discount for qualityThe price adjustment when delivered goods differ from the contract's quality specification — a 1:2 discount on castor seed below 47%, and contract rate times 999/995 for .999 gold on a .995 basis.
- Principal riskThe risk of having paid or delivered without receiving the other side — the settlement half of counterparty risk, eliminated by a central counterparty acting through novation.