How can a futures trader exit a position prior to expiration?

By Chad Langager AAA
A:

A futures contract is an agreement to buy or sell a commodity at a pre-determined price and quantity at a future date in time. While this is similar to an option, where the holder has the right to purchase the underlying security, a futures contract makes both parties to the contract obligated to deliver on the terms of the contract if it is held to settlement. If you do buy a futures contract, you are entering an agreement to purchase the underlying security and if you sell a futures contract you are entering an agreement to sell the underlying asset to another party. (To better understand this concept, read Futures Fundamentals.)

Over the life of a futures contract, the underlying security will likely move in favor of one holder over the other. So what can the holder with the profit do if they would rather exit the profitable position than hold to settlement? If a futures trader wants to close out a position all he or she needs to do is take an equivalent position that is opposite to the contract he or she already owns. So if you are long three February pork belly contracts, to close this position you would sell three February pork belly contracts.

However, usually this is not done by just selling your existing three contracts to another party, like you would a stock. The positions is usually closed out by entering into a new arrangement with another party. For example, if you purchased three contracts from party A, to close out your position you would sell three contracts to party B. Because these positions are offsetting your position in the market is neutralized and you are effectively out of the position. While this is a little more complicated than just selling the original three contracts, it is the same result.

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