What is meant by the term 'physical delivery' in futures contracts?

The term 'physical delivery' in futures contracts refers specifically to the actual exchange of the underlying commodity when a futures contract expires. This process involves the seller delivering the specified quantity of the commodity to the buyer at a predetermined location. Physical delivery is a key aspect of many futures contracts and ensures that the transaction is concluded with the buyer receiving the actual commodity, rather than settling the contract through cash payments or other means.

This concept is essential in commodity trading as it solidifies the agreement between parties regarding the specific item being exchanged, in contrast to other settlement methods like cash delivery where the obligation would simply be resolved through financial transactions without the movement of goods. Understanding physical delivery is crucial for anyone involved in commodity markets, as it affects logistics, quality requirements, and pricing dynamics associated with the actual commodity being traded.