THE UNANTICIPATED DELIVERY OF A FUTURES CONTRACT

This story (which may well be fictional) concerns a new employee of a financial institution who had no prior experience in the financial sector. One of their clients regularly entered into a long futures contract (buy position) on live cattle for hedging purposes and issued instructions to close out the position (sell position) on the last day of trading. (Live cattle futures contracts are traded by the CME Group and each contract is on 40,000 pounds of cattle). The new employee was given responsibility for handling the account.

On the day of expiry, the employee instructed the trader/broker at the exchange to buy one contract (instead of asking him to sell). The result of this mistake was that the financial institution ended up with a long position in two live cattle futures contracts. By the time the mistake was spotted, the trading in the contract had ceased. The financial institution (not the client) was responsible for the mistake.

If positions in exchange-traded futures contracts are left open the long and short may have to look for physical delivery arrangements, which this firm had never done before. As per the terms of the contract, the short position can deliver the cattle to a number of different locations in the US during the delivery month. Because it was long, the financial institution could do nothing but wait for a party with a short position to issue a notice of Intention to Deliver to the exchange and for the exchange to assign that notice to the financial institution.

The firm eventually received a notice from the exchange and found that it would receive live cattle at a location 2,000 miles away the following Tuesday. The new employee was sent to the location to handle things. It turned out that every Tuesday there was a cattle auction at this location. The party with the short position was planning to buy the cattle at the auction and then immediately deliver it to the financial institution. Unfortunately, the firm could not resell the cattle until the next auction the following Tuesday. The employee was asked to stay back and make arrangements for the cattle to be housed and fed for a week.

This was his great start to a first job in the financial sector!

Source – Options, Futures, and other Derivatives (Ninth Edition), John. C. Hull