As we discussed previously, when a trader goes long or short on a position, he can close his position prior to expiration by executing a reversing transaction that is exactly the same as his original trade. The clearing house views the trader as holding a long and short position that offset each other, causing the trader's position to be flat. This is the same as having no position at all.

Example: Closing a Futures Position
You have entered a long position in 30 December S&P 250 contracts, in August. Come September, you decide that you want to close your position before the contract expires. To accomplish this, you must short, or sell the 30 December S&P 250 contract. The clearing house sees your position as flat because you are now long and short the same amount and type of contract.

Terminating Futures Contracts

  • Close-Out (offset) at Expiration - If a trader holds a long position, she can go short the same contract with regards to the terms of the original trade and vice versa for the short position trader. Prices may differ because of market conditions.
  • Delivery - Here, the long position keeps the position open at the end of trading on the expiration date. This requires the long holder to accept delivery of the underlying asset and pay the short position the Pre agreed Future price.
  • Equivalent Cash Settlement - Some contracts are designated as cash-settle contracts. At expiration, the trader keeps his position open. When the contract expires, the margin account is marked to market and the gain is posted in the account. The reason that a gain is posted is because in most cases the trader would close out the position prior to expiration if it is a loser.
  • Exchange-for-Physicals - These are used for futures participants. Here the long and short holders arrange alternative delivery procedures. For example, if the exchange requires the physical delivery of the asset in Chicago, the parties may agree to make settlement outside of the required area, say Pittsburgh. The parties will have to report to the Chicago Board of Trade that the transaction was settled outside the normal procedures. This is satisfactory to the exchange.


Other Types of Derivatives

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