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KembaraXtra – Islamic Derivatives: Cash Settlement in Futures Contracts (Detailed Explanation & Case Analysis)
🔹 What is Cash Settlement?
Cash settlement means:
👉 No physical delivery of goods
👉 Only the price difference (profit or loss) is paid in cash at the end of the contract (or daily)
🔹 Key Idea
👉 It is a financial settlement, not a real trade of goods
🔹 How It Works (Step-by-Step)
🔹 Case Analysis (Palm Oil 🌴)
📌 Initial Agreement
📅 Scenario 1: Price Rises
👉 Difference = RM800
👉 Seller pays RM800 to buyer
✔ No palm oil is delivered
📅 Scenario 2: Price Falls
👉 Difference = RM800
👉 Buyer pays RM800 to seller
✔ Again, no goods involved
🔹 With Margin System (Important)
🔹 Why Cash Settlement Is Used
🔹 Problem from Shariah Perspective
Cash settlement raises concerns because:
👉 Looks like trading on price movements only
🔹 Simple Summary
🔹 What is Cash Settlement?
Cash settlement means:
👉 No physical delivery of goods
👉 Only the price difference (profit or loss) is paid in cash at the end of the contract (or daily)
🔹 Key Idea
- Instead of exchanging actual goods (like palm oil),
- Parties only exchange money based on price movement
👉 It is a financial settlement, not a real trade of goods
🔹 How It Works (Step-by-Step)
- Agree on a futures price today
- Market price changes over time
- At settlement:
- Compare market price vs contract price
- Pay the difference in cash
🔹 Case Analysis (Palm Oil 🌴)
📌 Initial Agreement
- Futures price = RM4,000
- Quantity = 1 ton palm oil
- No physical delivery (cash settlement)
📅 Scenario 1: Price Rises
- Market price = RM4,800
👉 Difference = RM800
- Buyer (long) gains RM800 ✅
- Seller (short) loses RM800 ❌
👉 Seller pays RM800 to buyer
✔ No palm oil is delivered
📅 Scenario 2: Price Falls
- Market price = RM3,200
👉 Difference = RM800
- Buyer loses RM800 ❌
- Seller gains RM800 ✅
👉 Buyer pays RM800 to seller
✔ Again, no goods involved
🔹 With Margin System (Important)
- These gains/losses are often:
- Paid daily (mark-to-market)
- Margin ensures:
- Money is available
- No default happens
🔹 Why Cash Settlement Is Used
- Easier than delivering goods
- Faster and more efficient
- Used when:
- Goods are difficult to deliver
- Traders only want profit from price changes
🔹 Problem from Shariah Perspective
Cash settlement raises concerns because:
- ❌ No real exchange of goods
- ❌ Only money differences traded
- ❌ High speculation (maisir)
- ❌ Uncertainty (gharar)
👉 Looks like trading on price movements only
🔹 Simple Summary
- Cash settlement = no goods, only money difference
- Profit/loss = market price − contract price
- Widely used in futures markets
- ❌ Problematic in Islamic finance
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