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Liquidation has two meanings depending on its context.

As a business and legal term, liquidation refers to the closing of a business and distribution of its assets to the creditor and/or owners of the business.  Most often, liquidation happens in the context of a bankruptcy.  A bankruptcy trustee will sell the business assets and distribute the proceeds to the creditors.  After that, the business’s debts are discharged.   In the rare instance where the creditors have been fully paid, any remaining proceeds are paid to the owners.

Liquidation can also occur with respect to one particular asset that is used to collateralize a loan.  For instance, if a business defaults on a loan with a bank, and had pledged its inventory as collateral for the loan, the bank will seize the inventory and liquidate it (sell it to the public), then use the proceeds to pay off the loan.  Unlike bankruptcy, most loan agreements hold the business responsible for any loan amount remaining should the inventory proceeds not pay off the entire loan. 

Where an investor is trading options on margin, liquidation means closing out a long or short position by offsetting it with the opposite position. This usually happens when the equity in the trader’s brokerage account falls below the required margin. Liquidation also occurs when an option is sold for its fair market value before its expiration date. A trader might do this to realize a quick profit on the option instead of waiting until the expiration date.

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