What is a Delivery Option?

Malcolm Tatum

A delivery option is a provision that is found in many different types of futures contracts. Often, this option plays a role in determining when the underlying commodity associated with the contract will be delivered. Factors such as the quality of that commodity, location, timing and the total quantity identified in the contract as stated in the delivery notice will make a significant difference in how the delivery option is structured. Since there are normally several ways that the deliverer can choose to fulfill the contract, it is a good idea for the investor to look closely at all possible options before proceeding with the deal.

Man climbing a rope
Man climbing a rope

Depending on how the delivery option is structured, this provision can provide considerable leeway for the deliverer of the commodity associated with the futures contract. For example, the factors of quantity and timing may allow the deliverer to choose a delivery date that is different from the time frame anticipated by the investor. When this is the case, the investor may or may not realize the anticipated return from the investment. From this perspective, the way that a delivery option is constructed can mean that the investor takes on additional risk, while the risk for the deliverer is minimized.

With the ability to include a delivery option that is affected by several criteria, many investors refer to this provision as a wildcard option. This reflects the realization that the deliverer does have some flexibility in when the underlying commodity is actually delivered, and in what form. It is important to keep this in mind when evaluating an investment in any commodity with the use of a futures contract. While the delivery will often occur according to terms that are agreeable for the receiver, there is always the risk of some sort of delay that may reduce the level of return anticipated.

A delivery option is also common with minimum price contracts and interest rate futures contracts as well as with futures contracts that involve commodities. The same basic rules of delivery will apply, with most of the same variables being relevant to this type of futures agreement. Before entering into this type of contract, an investor would do well to consider the several different ways that the contract allows the seller to fulfill the terms, analyze each potential outcome carefully, and determine if the return from most or all of those possibilities is within a satisfactory range.

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