Exchange of Physicals:
A trader can also complete the futures contract by engaging in exchange of physicals. In this method, the parties agree to exchange cash and the commodity underlying the contract. A baker who genuinely requires wheat and a farmer who has wheat can mutually agree on a price for the wheat, so that the exchange can take place, in the process facilitating both the traders to cancel their complementary futures position against each other. The exchange notes their positions and cancels their futures obligations.
This method is quite similar to the offsetting method, but differs from it in the following manner:
- the traders actually exchange physical goods;
- the transaction or the mutual agreement does not take place on the floor of the exchange; and
- there may be no intermediaries to negotiate the deal.
Keeping the above points in view, an exchange for physical is also called "Ex-pit" transaction or "Against actuals" or "Versus cash" transaction and is recognized by the Federal laws and Exchange rules.
In the discussion on margins, we considered the manner in which the margins are calculated for a futures contract. However, this was only for a single contract. In the real world, traders seldom deal in single contracts. Since the objective of margins is to protect the trader, the broker and the clearing house against losses, it will make sense to ask traders to pay margins depending on: (i) his cumulative position; and (ii) the risk he is exposed to in different markets. Certainly, it will improve the liquidity position and also release the funds locked up in margins.