How will the futures contract be settled?
In this scenario, since the futures contract is cash settled, the settlement will be done in monetary terms rather than physical delivery of oil. As the market price of oil upon expiry is $30 per barrel, which is higher than the contract price of $25 per barrel, the futures contract will be settled with a cash payment. The contract holder will receive the difference between the market price and the contract price for the specified quantity of oil, which in this case would be a profit of $1,000.
Understanding Cash Settled Futures Contracts
Cash settled futures contracts are financial agreements that specify the delivery of an underlying asset in cash rather than the physical delivery of the asset itself. In the case of the scenario provided, a contract was entered into to sell 200 barrels of oil at a price of $25 per barrel with settlement to be made in 6 months.
Settlement Mechanism in Cash Settled Futures
The settlement in a cash settled futures contract is based on the price difference between the contract price and the market price at the time of expiry. The contract holder does not have to physically deliver or take delivery of the underlying asset, in this case, barrels of oil.
Profit from Price Difference
In the given scenario, the market price of oil has risen to $30 per barrel at the expiry of the contract, resulting in a profit opportunity for the contract holder. The settlement amount is calculated by multiplying the price difference between the market price and the contract price by the quantity specified in the contract. In this case, the profit would be ($30 - $25) * 200 = $1,000.
Therefore, the correct answer is b) You will receive $1,000. The contract holder will receive a cash payment of $1,000 as a result of the price difference between the futures contract and the market price at expiry.