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Cash-settled

This is your classic equity derivative: given that much of the point of equity swaps is to invest synthetically in securities you either don’t want to, or cannot, own physically — or instruments like indices that you can’t own. The great preponderance of delta one equity swaps which makes up the synthetic prime brokerage business, will be cash settled at all times.

Physically-settled

Some quick thoughts on where physical settlement is likely in equity derivatives.

Firstly, in ordinary equity swaps, the avowed intent of a customer is generally to avoid having a physical position in the share itself thereby appearing on the share register and possibly being in scope for various tax consequences it might rather avoid, so it would tend to be very unusual for a equity swap transaction to be physically settled.

In equity options world similar considerations apply although occasionally particularly in US markets listed options can be settled physically, although as far as JC knows only a very small part of the market in practice takes physical settlement.

You may see physical settlement in Forward Transactions. Two main scenarios here: firstly, common or garden financing: where a long-term investor wants to raise funding against a static position it will execute a spot sale and a forward purchase, and in that case will want the shares returned.

Secondly, in financing arrangements where banks are helping investors acquire large positions, for example by providing a financed collar structure with physical settlement that allows the investor to finally take possession of the shares while managing its downside risk, or in some M&A situations where derivatives are used to manage stake-building.

In essence, you will see physical settlement of equity derivatives where a customer’s end goal is to own shares and not just to get economic exposure. Here, derivatives are used as tools to manage the acquisition process rather than for pure investment purposes.