What is the settlement price?
The settlement price is the price that is typically used in the mutual fund and derivatives markets to determine the daily profit or loss of a position and the corresponding margin requirements.
The settlement price may also refer to the ultimate price that an underlying asset obtains in relation to options contracts, in order to ascertain whether they are in-the-money (ITM) or out-of-the-money (OTM) at expiration and what their payoffs should be.
As an alternative, the net asset value (NAV) of mutual funds or exchange-traded funds (ETFs) may be determined on a daily basis using settlement prices.
KEY POINTS
- The settlement price is the price at which an asset closes or the price that a derivatives contract will reference at the conclusion of each trading day and/or upon its expiration.
- The settlement price will be established on the settlement date of a specific contract.
- There is no universal standard for the calculation of settlement prices across asset classes, resulting in significant variation in the settlement prices of equivalent contracts across exchanges.
Comprehending Settlement Prices
The reference price for designating the value of open derivatives contracts or evaluating their value upon expiration is a settlement price.
On the date of settlement, this price is acquired.
The settlement price is calculated in a variety of methods and is typically established by established procedures that vary slightly based on the traded instrument and the exchange.
Settlement prices are generally determined by the average price over a specific time frame.
The opening and closing prices may be used to compute these prices, or they may be determined by the activity that occurs within a specific time frame within a trading day.
The closing price is the price of a specific security at the end of the same trading day, while the initial price refers to the price of a specific security at the commencement of the trading day within a specific exchange.
In the event that securities are traded on multiple markets, the closing price may differ from the opening price of the following day as a result of off-hours activity that takes place while the first market is closed.
Although the opening and closing prices are typically managed in a consistent manner across exchanges, there is no universal standard for determining settlement prices in different exchanges, resulting in discrepancies across global markets.
Important: Settlement prices are often based on the average price of the contract over a specified period, calculated at both the open and close of each trading day, though not all markets use the same formula.
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Establishing Settlement Prices in Specific Markets
The settlement price is typically established by calculating the weighted average price over a specific trading period, which is typically conducted shortly before the market closes.
The settlement prices of specific equity futures on the Chicago Mercantile Exchange were determined by a volume-weighted average of pit trading activity in the 30 seconds between 3:14:30 p.m. and 3:15:00 p.m.
Central Daylight Time (CDT). The time was changed to 12:59:30 p.m. and 1:00:00 p.m. in December 2014.
The previous 30-second window will be maintained, but it will be based on a distinct time period, as indicated by CDT.Twelve
Another example is the Moscow Exchange (MOEX), where settlement prices for the RTS Index and MICEX Index are determined by activity between 3:00 p.m. and 4:00 p.m. on the previous trading day.
The Russian Volatility Index employs a distinct time frame, concentrating on activity between 2:03:15 p.m. and 6:00:00 p.m.3
Illustration of the Settlement Price
The owner of a call option with a strike price of $100 and the settlement price of the underlying asset at its expiration is $120 is able to purchase shares for $100.
These shares can then be sold for a $20 profit, as the option is in-the-money. If, however, the settlement price was $90, the options would expire void due to their OTM status.
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