Introduction
Notice day plays a crucial role in financial markets, particularly in derivatives and futures trading. As someone who has worked in finance for years, I’ve seen firsthand how misunderstanding notice day can lead to unexpected obligations or missed opportunities. In this article, I’ll break down what notice day means, why it matters, and how traders, investors, and corporations use it to manage risk.
Table of Contents
What Is Notice Day?
Notice day refers to the specific date when a party involved in a futures or derivatives contract must notify the counterparty of their intention to deliver or take delivery of the underlying asset. This concept is most relevant in physically settled contracts, where the actual commodity or security changes hands rather than a cash settlement.
For example, in corn futures traded on the Chicago Board of Trade (CBOT), the seller must issue a notice of delivery to the buyer before the contract expires. The buyer, in turn, must be prepared to accept delivery. Missing this deadline can result in penalties or forced liquidation.
The Mechanics of Notice Day
Key Components
- First Notice Day (FND) – The earliest date a seller can declare intent to deliver.
- Last Notice Day (LND) – The final date for submitting delivery notices.
- Delivery Period – The window between FND and LND where delivery can occur.
Different exchanges have varying rules. For instance, the CME Group sets FND and LND based on contract specifications.
Mathematical Representation
The delivery process can be modeled using a timeline function:
Delivery\:Period = [FND,\: LND]Where:
- FND = First Notice Day
- LND = Last Notice Day
If a trader holds a long position and does not want physical delivery, they must exit before FND.
Why Notice Day Matters
Risk Management
Futures traders often use contracts for hedging or speculation, not for actual delivery. Failing to account for notice day can force an unwanted obligation. Imagine a hedge fund trading crude oil futures—if they overlook notice day, they might end up with thousands of barrels of oil to handle.
Pricing Implications
As notice day approaches, futures prices converge with spot prices due to arbitrage. The theoretical futures price F_t can be expressed as:
F_t = S_t \times e^{(r - q)(T - t)}Where:
- S_t = Spot price at time t
- r = Risk-free rate
- q = Cost of carry (storage, insurance, etc.)
- T - t = Time to maturity
As t nears T, F_t and S_t align, impacting trading strategies.
Notice Day in Different Markets
Agricultural Commodities
Farmers and food processors rely on notice day to lock in prices. For example, a wheat farmer might sell futures to hedge against price drops. If they don’t close the position before FND, they must deliver the wheat.
Financial Derivatives
In interest rate futures, notice day determines when cash settlement occurs. Eurodollar futures, for instance, settle in cash, so notice day is less about delivery and more about finalizing the contract.
Metals and Energy
Gold and oil futures often involve physical delivery. Large institutions like refineries use notice day to coordinate logistics. Missing LND can disrupt supply chains.
Example Calculation: Notice Day Impact
Suppose I hold a December corn futures contract with:
- FND: November 20
- LND: December 14
- Current Date: November 18
If I don’t exit by November 20, I risk delivery. The cost of rolling over the position depends on the spread between December and March futures.
Rolling\:Cost = F_{Dec} - F_{Mar}If F_{Dec} = \$5.20\ bushel and F_{Mar} = \$5.40\ bushel, the roll costs \$0.20\ bushel.
Notice Day vs. Expiration Day
Many confuse notice day with expiration day. While expiration marks the end of trading, notice day dictates delivery obligations. Some contracts expire before notice day, while others allow post-expiration notices.
Aspect | Notice Day | Expiration Day |
---|---|---|
Purpose | Delivery declaration | Final trading day |
Timing | Before or after expiration | End of contract lifecycle |
Impact | Physical/cash settlement | Position closure |
Legal and Operational Considerations
Exchange Rules
Each exchange sets notice day rules. The CBOT requires sellers to submit a “Delivery Notice” by a specified time. Failure means penalties.
Brokerage Policies
Some brokers auto-liquidate positions before FND to prevent delivery. Always check your broker’s policy.
Common Mistakes and How to Avoid Them
- Ignoring FND – Traders forget to exit positions, leading to unwanted deliveries.
- Misunderstanding Roll Costs – Rolling futures incurs costs that affect profitability.
- Assuming Cash Settlement – Not all futures are cash-settled; some require physical handling.
Conclusion
Notice day is a critical yet often overlooked aspect of derivatives trading. Whether you’re a hedger, speculator, or arbitrageur, understanding its mechanics helps avoid costly errors. By tracking FND, LND, and contract specifications, traders can navigate markets more effectively.