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?

    Calculate the notional value of a futures contract by multiplying the size of the contract by the price per unit of the commodity ... Read Full Answer >>
  2. What assumptions are made when conducting a t-test?

    The common assumptions made when doing a t-test include those regarding the scale of measurement, random sampling, normality ... Read Full Answer >>
  3. How do futures contracts roll over?

    Traders roll over futures contracts to switch from the front month contract that is close to expiration to another contract ... Read Full Answer >>
  4. Why do companies enter into futures contracts?

    Different types of companies may enter into futures contracts for different purposes. The most common reason is to hedge ... Read Full Answer >>
  5. What does a futures contract cost?

    The value of a futures contract is derived from the cash value of the underlying asset. While a futures contract may have ... Read Full Answer >>
  6. How are double exponential moving averages applied in technical analysis?

    Double exponential moving averages (DEMAS) are commonly used in technical analysis like any other moving average indicator ... Read Full Answer >>
Related Articles
  1. Technical Indicators

    Understanding Trend Analysis

    Trend analysis is the use of past performance to predict future price movement of a security.
  2. Investing Basics

    Understanding the Spot Market

    A spot market is a market where a commodity or security is bought or sold and then delivered immediately.
  3. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  4. Trading Strategies

    How To Buy Penny Stocks (While Avoiding Scammers)

    Penny stocks are risky business. If want to trade in them, here's how to preserve your trading capital and even score the occasional winner.
  5. Investing Basics

    5 Things to "Deliberately" Do to Improve Your Trading

    Most traders are putting in trading hours, but not improving. Here are deliberate steps that can take your trading to the next level.
  6. Chart Advisor

    Stocks to Short...When the Dust Settles

    Four short trades to consider, but not quite yet. Let the dust settle and wait for a pullback to resistance for a higher probability trade.
  7. Technical Indicators

    Using Moving Averages To Trade The Volatility Index (VIX)

    VIX moving averages smooth out the natural choppiness of the indicator, letting traders and market timers access reliable sentiment and volatility data.
  8. Chart Advisor

    Strategizing for a Market Fall...or Rally

    The downtrend isn't confirmed yet, so be prepared with trades for whether the stock market rallies or continues to fall. Here's how to do it.
  9. Investing Basics

    Explaining Forward Rate Agreements

    Forward rate agreement (FRA) refers to an interest rate or foreign exchange hedging strategy.
  10. Trading Strategies

    Are You a Trend Trader or a Swing Trader?

    Swing traders and trend traders execute market timing strategies that require different skill sets.
RELATED TERMS
  1. Derivative

    A security with a price that is dependent upon or derived from ...
  2. Inverse Transaction

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

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

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

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

    Indicators are statistics used to measure current conditions ...

You May Also Like

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!