In the financial markets, a trade occurs when a seller's price matches a buyer's offer. Once matched, the buyer receives the underlying asset at the “delivery price”. It is a basic concept that defines the terms of transactions between buyers and sellers. Let us understand the delivery price in detail, comprehend its meaning across different financial instruments, and see how analysing it promotes value investing.
What is the delivery price?
Delivery price refers to the price at which the securities are bought or sold. Investors must note that the meaning of delivery price varies across different financial instruments used in the stock market. Let us understand them:
| Financial instrument | What is the meaning of delivery price? | How is the delivery price fixed? |
| Stocks | The delivery price is the agreed-upon price at which the buyer purchases the stock from the seller for delivery into their demat account. | This price is determined by the prevailing market conditions at the time of the transaction. |
| Futures contracts | The delivery price is the price specified in the futures contract at which the buyer agrees to purchase the underlying asset (such as stocks, commodities, or currencies) from the seller at a future date. | The delivery price is fixed at the time the futures contract is initiated. It remains constant throughout the contract's duration. |
| Options |
|
The delivery price is specified in the options contract. It remains fixed until expiration. |
| Forward contracts | In forward contracts, the delivery price is the price agreed upon by the buyer and the seller for:
|
The delivery price is negotiated based on:
|
What is the relationship between delivery price and forward price?
It must be noted that initially, the delivery price of a forward contract is similar to its forward price. However, over time, the forward price fluctuates, but the delivery price remains constant.
Let us understand this concept better through a hypothetical example:
Setting forward price
- Consider a forward contract for 100 shares of XYZ Ltd.
- The buyer and seller of this contract have decided on a forward price of Rs. 250 per share.
- This contract will expire in six months.
The delivery price
- Initially, the forward price is similar to the delivery price, which is the price at which the asset will be delivered upon expiration of the contract.
- Hence, the delivery price is also Rs. 250 per share.
The fluctuations
- As time passes, the forward price fluctuates due to changes in market conditions, such as:
- Interest rates
- Supply and demand conditions, and
- Geopolitical events
- These factors cause the market price of XYZ Ltd. shares to increase to Rs. 270 per share.
- Despite this increase in the market price, the delivery price remains fixed at Rs. 250 per share.
The impact on the parties involved
- Buyer's perspective
- The buyer of the forward contract benefits as the market price of XYZ Ltd. shares (Rs. 270) has risen above the forward price (Rs. 250).
- They can now purchase the asset at the lower delivery price (Rs. 250) as agreed upon initially.
- Seller's perspective
- The seller of the forward contract will incur losses.
- They are obligated to sell the asset at the lower delivery price (Rs. 250).
How are delivery-based transactions settled?
Usually, investors engage in delivery-based transactions with the intention of holding them for a longer period, typically more than one trading day. This type of trading differs from intraday trading, where transactions are settled within the same trading day.
In delivery-based transactions, securities are transferred from the seller's demat account to the buyer's demat account at the delivery price. In India, this settlement process takes one trading day (T+1 settlement cycle; T+0 from March 2024).
How does analysing delivery price promote value investing?
By paying attention to delivery price, investors can follow a value investing approach. It usually involves:
- Identifying undervalued stocks trading below their intrinsic value,
and - Investing in stocks with attractive delivery prices relative to their fundamentals
Let us understand how you can do it:
Step I: Identify investment opportunities
- Identify stocks that meet the following criteria:
- Low price-to-earnings (P/E) ratio
- Low price-to-book (P/B) ratio
- High dividend yield, or strong earnings growth
- Always look for companies with stable or growing revenues and cash flows.
- You can gather the required data for this step from popular financial websites.
Step II: Calculate intrinsic value
- Estimate the intrinsic value of the stock.
- You can use valuation methods, such as Discounted cash flow (DCF) analysis.
- Don’t forget to consider qualitative factors in your valuation analysis.
- Some important qualitative factors include:
- The company's competitive positioning
- Growth prospects
- Management quality
Step III: Compare delivery price with intrinsic value
- This is one of the most important steps where you compare:
- The calculated intrinsic value of the stock with
- Its delivery price
- Always look for stocks where the delivery price is lower than the intrinsic value.
- This way, you can identify and invest in undervalued stocks.
Step IV: Always diversify
- To spread out investment risk, diversify your investments across different sectors and industries.
- Also, regularly monitor the performance of your portfolio.
- Keep adjusting your portfolio based on new information or changing market situations.
Conclusion
In the context of the share market, the delivery price is the price at which a trade gets executed. It shows the lowest price a seller is willing to accept and the maximum price a buyer is willing to pay. However, the meaning of delivery price varies with the financial instrument in question. By analysing delivery price and comparing it with the intrinsic value of a stock, investors can identify undervalued stocks and adopt a value investing approach.
Are you looking to learn more about dividends? Understand what are dividend stocks and what it means when a stock turns ex-dividend.
