Delivery Provisions

Most positions are offset, but a minority go to delivery. To keep those deliveries workable, the exchange defines exactly what quality is deliverable and how substitute qualities are priced.

Basis Grade

Delivery starts with a single benchmark quality that the quoted price refers to.

• Basis grade (also called the par grade or contract grade): the standard grade or quality of the commodity specified in the futures contract as deliverable at the contract price, with no price adjustment.
• The basis grade is the benchmark against which every other deliverable grade is priced.
• The quoted futures price is the price for delivery of the basis grade.

In plain terms, when a trader sees a futures price on the screen, that price is the price to deliver the basis grade. Any other grade will settle at that price plus or minus an adjustment.

Deliverable Substitutes at Premiums and Discounts

Contracts rarely allow only one exact grade, because that would make the deliverable supply too thin and too easy to corner.

• Many contracts let the short deliver certain grades other than the basis grade, so that enough supply is deliverable and the contract cannot be easily squeezed.
• Premium: a price added to the contract price when the short delivers a grade better (higher) than the basis grade, so the short is paid more for the superior grade.
• Discount: a price subtracted from the contract price when the short delivers a grade lower than the basis grade, so the short receives less for the inferior grade.
• These premiums and discounts (the allowed differences from the basis grade) are set by the exchange, not negotiated per delivery. A delivery of a substitute grade settles at the contract price adjusted by the fixed premium or discount for that grade.
• The right to choose which permitted grade to deliver generally belongs to the short (the party making delivery).

Think of it this way: the short is the one handing over the goods, so the short picks which approved grade to deliver. A higher grade is worth more, so the buyer pays a premium for it; a lower grade is worth less, so it comes at a discount. The adjustment always tracks the quality.

Exam Tip: Gotchas

• Match the direction correctly. A better or higher grade earns a premium (paid above the contract price); a lower grade is delivered at a discount (below the contract price). Reversing them is the classic delivery-provisions trap. Anchor on "premium equals superior grade equals more money."
• The short chooses the deliverable grade. The right to pick which permitted grade to deliver belongs to the party making delivery (the short), not the long.

Two Different Meanings of "Basis"

One word does double duty in futures, and the exam knows it.

• The basis grade covered here is strictly the standard deliverable quality: the grade deliverable at the contract price.
• Elsewhere on this exam, basis means the difference between the cash price and the futures price, a hedging concept developed in the hedging and basis-calculation units.
• These are different concepts that happen to share a root word. Keep them separate.

Exam Tip: Gotchas

• Do not confuse the delivery "basis grade" with the hedging "basis." The basis grade is a quality standard for delivery. The hedging basis is cash price minus futures price. Same word, unrelated ideas.