Cash settled futures might be coming to the PSX. What are they and why do they matter?

In a recent interview, Farrukh H Sabzwari, the new Chief Executive Officer (CEO) at Pakistan Stock Exchange (PSX), has hinted towards the fact that cash settled futures and options are being considered as being introduced to the local market. There are plans to introduce these derivatives in the market after testing them by March of 2025. This is expected to increase liquidity and is preferred by traders as they have low capital requirements. 

What actually are cash settled futures and how do they differ from the mechanism that is in place currently?

Some basics 

To get an understanding of these future contracts, a basic comprehension of future markets is required. Usually it is understood that investors can buy or sell a share in the market. When people talk about transactions being carried out, it is a given that the regular market is being discussed where shares are traded and settled within a given time frame of two days. Investors who are buying the shares are expected to pay for these shares in two days while the seller has to guarantee delivery of the shares to the buyer against which he will get his sales proceeds.

The next step in this progression is where future contracts are traded. In the futures market, a buyer makes a commitment some time in advance that he will buy the shares at a given date in the future. The price of these contracts is tied to an underlying stock or share and are called derivatives as their value is derived from the stock itself. A buyer will buy the shares in the market on the 3rd of the month and will commit that when the trades are settled in the future, he will put up the funds needed in order to complete the transaction. Let us assume that the shares will be settled on the 30th of the month. Usually, the last Friday of the month is the final date of settlement.