1) Does net settlement have to occur under the terms of the contract?
No. Net settlement can occur under the terms of the contract, through a market mechanism, or by delivery of a derivative or other asset that is readily convertible to cash. Net settlement simply means that the parties end up in a financial position that reflects their respective net gain or loss resulting from the contract. This criteria is intended to exclude contracts that require physical settlement where the physically delivered asset is not readily convertible to cash. Commodities, publicly traded stocks, publicly traded bonds, and other physical assets with active trading markets are typically readily convertible to cash and would therefore meet this criteria. There are notable exception, like a publicly traded stock whose trading volume is very thin thereby making conversion of the stock received in physical settlement of the contract NOT readily convertible to cash. See _____ for an in-depth analysis of net settlement.
2) Can I assume physical or net settlement if my contract provides for both physical and net settlement?
If the contract provides for net settlement than this criteria is considered met, even if physical settlement is an alternative. These settlement terms are potentially revisited if the instrument is determined to be a derivative (i.e., if all three criteria are met).