Some futures contracts are cash-settled, others are settled via physical delivery.

For example, soybeans are physically delivered as part of the contract terms. They settle with the exchange of actual physical soybeans between buyer and seller.

SOFR futures -- much like their predecessors Eurodollars, which referenced LIBOR rates -- are cash-settled. Each day, buyers and sellers of SOFR futures will have their positions marked-to-market – or assessed in relation to the current market price of the asset – with the difference being credited or debited through payment or collection of variation margins. More information on how margin can be affected by price fluctuation can be found in this article. When the contract expires, participants’ positions will be marked-to-market one last time, in reference to the final settlement price, alongside a final cash settlement.

It is CME Clearing, in conjunction with the futures commission merchants (FCMs, a type of broker), that makes sure trader accounts are debited and credited accordingly and that cash settlements are made in a timely and accurate matter.

Assume that in January a trader bought March SOFR futures at a price of 95.75 when implied three-month compounded SOFR was about 4.25% (100.00 – 4.25 = 95.75).

The trader decides to hold onto the futures contract until the final settlement day, which occurs on the business day prior to the third Wednesday of the contract delivery month.

Final settlement of an expiring Three-Month SOFR contract is 100 minus the realized compounded daily SOFR during the contract reference period, also known as R.

The SOFR is published by the New York Fed each business day at around 8:00 a.m. Eastern Time (ET). These published rates are then used in a calculation to find the three-month compounded SOFR rate. For more information about how the three-month compounded SOFR rate is calculated, see this resource.

Returning to our example, say that the realized compounded rate for the Three-Month SOFR contract ended up being 4.19%. The final settlement is determined by subtracting this rate from 100.00.

100.00 – 4.19 = 95.81 = the final settlement price of the March SOFR settlement.

If the trader originally bought the futures at 95.75, and they settled at 95.81, the trader would make 6 basis points of profit. Since the basis point value of the contract is $25, the trader would have made $150 per contract.

The clearinghouse, working through the trader’s broker, will have credited his account with $150 cash through the life of the trade.