Dec '25 • 💻 Technical Skills
Physical Settlement in Option Contracts
A new video has been added to the online course 5.20 , which is in the Classroom.
This course is about Option Contracts on crude oil.
This video specifically shows what 'physical settlement' means.
Below I explain the key points of what this video shows. For a detailed explanation, the video is ideal.
There is also 1 screenshot attached.
Physical Settlement is a specific property/ specification of an option contract.
Let's assume today is the 1st of December 2025. A company (e.g. a refinery) buys 1 American Call Option on crude oil. This option is on 1000 barrels of crude oil.
The company pays $8000 to buy this option. Now that it owns it, it can exercise it anytime before it expires. The option expires on the 31st of December 2025, i.e. 30 days from today.
The strike price of the option is $70/barrel.
The company sees that the underlying asset (crude oil) sells for $78.5 /barrel i.e. its spot price is higher than the strike price of the option.
So the company exercises the option.
See the attached image. It has 3 stages. The first stage is when this option is exercised. At this moment the option is converted into a futures contract. This process is known as 'futures settlement'.
Second stage: this is the period until the futures contract expires. During this period the company can sell the futures contract or keep it.
If it keeps it, then we have the 3rd stage which happens after the futures contract expires and it is when the physical delivery takes place where the underlying asset (the crude oil) actually moves from the seller of the crude oil (a company that produces /extracts crude oil) to the buyer of the crude oil (the company that has the futures contract, which expired).
Here , the company pays $70/barrel * 1000= $70,000 and gets ownership of 1000 barrels of crude oil in the storage facility.
This is illustrated below.
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Physical Settlement in Option Contracts
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