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.

RELATED FAQS

  1. How can I calculate the notional value of a futures contract?

    Learn how the notional value of a futures contract is calculated, and how futures are different from stock since they have ...
  2. What assumptions are made when conducting a t-test?

    Learn what a t-test is, and discover the five standard assumptions that are made regarding the validity of sampling and data ...
  3. How do futures contracts roll over?

    Learn about why futures contracts are often rolled over into forward month contracts prior to expiration, and understand ...
  4. Why do companies enter into futures contracts?

    Learn how companies use futures contracts for the purposes of hedging their exposure to price fluctuations as well as for ...
RELATED TERMS
  1. Inverse Transaction

    A transaction that can cancel out a forward contract that has ...
  2. Best To Deliver

    The security that is delivered by the short position holder in ...
  3. Exchange Traded Derivative

    A financial instrument whose value is based on the value of another ...
  4. Fintech

    Fintech is a portmanteau of financial technology that describes ...
  5. Indicator

    Indicators are statistics used to measure current conditions ...
  6. Intraday Momentum Index (IMI)

    A technical indicator that combines aspects of candlestick analysis ...

You May Also Like

Related Articles
  1. Options & Futures

    How can I calculate the notional value ...

  2. Chart Advisor

    ChartAdvisor for July 30 2015

  3. Trading Strategies

    Microsoft's Game of Catch-Up With The ...

  4. Mutual Funds & ETFs

    ETF Analysis: PowerShares DB US Dollar

  5. Charts & Patterns

    Avoid The Perfection Trap In Trading

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!