Question

Consider a fairly illiquid futures contract that has not traded for days. How would the exchange come up with its settlement price?

Answer 1

The settlement price in a derivative market is the reference price used for computing the profit or loss in the day and for also assessing the additional margin requirements which may be necessary.

It is the average of the price at which the contract gets traded at opening and close. For a contract which has not been traded frequently or is illiquid as a result, the settlement price is computed using a model and the forward curve which is derived from the limited data available from the market. Thus the settlement price is calculated using a formula and the model based approach in the event of illiquidity of certain contracts.