You've heard of the closing price for a security. It's a relatively simple concept: it's the price of a security when trading finishes for the day.
A settlement price is a little more complex. Rather than just the specific price at the relatively arbitrary moment that marks the end of the trading day, the settlement price is based on the average price of a contract over the course of the session.
The concept gets used in derivatives trading (things like futures and options). The settlement price plays into calculations of profit and loss, as well as other market considerations (figuring out margin requirements, price limits for the following day, etc.).
Think of a basketball game (or any team sporting event, really). Usually, the winner is determined by the team that has the highest score at the end of a game. So...one team trails another throughout the game, but in the last few seconds, comes back and takes the lead for the first time with the final shot. The comeback kids are the winners. That's how a closing price works.
Now imagine that the winner isn't decided by the final score, but by the average score differential throughout the game. The teams have a "settlement score" at the end, instead of a closing score. Then the team that led the whole game could still come out winners in the end, even though they fell behind in just the last few seconds.
Related or Semi-related Video
Finance: What are Dividends: Declaration...15 Views
Finance a la shmoop what are dividends? that is declaration date ex-dividend
date pay date and record date yeah so you thought you could just invest in the [Money transfers to market for stock]
stock pay 20 bucks a share and get to know 30 cents a share in dividends four
times a year right? That was all you needed to know oh yeah not so easy well maybe
it is easy but things are never so simple on the street the mean street you
know the Wall Street when you buy a share of stock that pays a dividend a
whole bunch of technical questions get asked and they basically all revolve [Question marks revolving around a stock]
around whether or not you are entitled to that thirty cents and if you think
about it dividends have been around for a long long time a whole bunch of
schemers out there trying to kind of ripoff that dividend in nefarious ways [Person tears off dividend from stock]
all right well why does it matter whether you're entitled to that thirty
cents or not well with all those nefarious people out there wouldn't you
think there are a whole bunch of sharpies they're trying to legally take [Man reading book of laws and loopholes]
advantage of the system like you know buying that $20 a share stock the day
before the dividend is payable holding the stock until that investor is owed
the dividend and then just selling the stock like five minutes later it's like
an ATM courtesy of equity stock dividend right good buy it and you sell it a [Person uses a equity stock dividends ATM]
couple days later make free profit move on well the markets are smarter than we
are and they adjust to that very quickly So anyway the laws have to
be crystal clear as they apply to that process or innocent people kind of get [Man locked away in a cell]
taken and each of the terms are on the technicals behind who gets what when in
the land of dividends matters a lot all right first up declaration date okay
that's the date when the board of directors publicly announces that they
will in fact pay a dividend along with the details relating to that dividend
like how big it will be the day you'll have to own the stock to be entitled to
receive that dividend and also the date that the dividend will actually be paid
all right so that's that next up the ex-dividend date and yes it [Laws appear]
sounds like something Charles Xavier and Magneto would argue about but in fact [Charles Xavier and Magneto appear]
it's not although that'd be a cool superhero to be like a ex-dividend
opposed to an x-men maybe that's like a Wall Street superhero
our lawyers are glaring at us right now the ex-dividend date is the last date
after which shares bought in a given company don't automatically have that
periods dividend attached so think about it like it's a Macy's white flower day [Macy's advert appears on TV screen]
sale discount on the share you're buying if you don't buy it by say
close of market Tuesday or whenever it is well then you don't get it that's the
ex-dividend date you don't get that freebie dividend discount when you buy
the share if you buy it after the close like at 4:01 p.m. on Tuesday you had to
buy it before the market closed on that Tuesday or whenever the ex-dividend date [Man stood next to clock]
was got it all right so all the other dates before this are called cum
dividend or with dividend such that anyone owning this stock at that period
has legal right to receive the dividend all right it is natural then for a $40
stock paying say a 50 cent dividend to naturally drop 50 cents the day after
the ex-dividend date comes into effect and in reality more or less this is what
happens albeit with many twists and turns in the market that is the stock
goes from 40 bucks to 39.50 a share you know the next minute so the key
delimiter date is the record date shareholders have to register their
ownership and yes your brokerage does that automatically usually of a given
share of stock on or before the date of record to get that dividend and
eventually when the dividend is finally paid magically that date is called the [Magicians stick taps stock and disappears in smoke]
pay date yeah shocker so yeah that's a lot of dates to keep track of kind of
reminds us of ourselves when we were in our 20s in college and had a social life
not anymore [Group of girls sitting together]
Up Next
What is spread (bid-ask)? The bid-ask spread compares how much a buyer will pay to how much the seller will sell for. The asking price is what the...
What is the Bid-to-Cover Ratio? The Bid-to-Cover ratio compares the amount of bids made for Treasury securities to the amount that is actually sold...