1

Suppose A takes a long position by buying a December gold futures contract in January, and B at the same time takes a short position by selling the contract. The orders from A and B are matched and the agreed price for December gold is $1000.

Assume that the December gold futures price goes like this:

January = $1000 → ... → November = $800 → December = $700

In November, at the end of the day, the balance in the A's margin account would be reduced by $200, and the B's margin account would be increased by $200. (Daily settlement)

In November, if A decides to close out the position by selling the contract. The futures price on that day is $800, so A would have a cumulative loss of $200 by closing out.

  1. Now what happens to B? If B holds the contract until December, he would have the right to sell the gold at $1000 while the price in the market is only (or should be very closed to) $700, meaning that B should gain $300. But his margin account has increased by only $200. Where would an extra $100 come from? To whom would B sell the gold?
  • When A sells his December contract in November for $800, where does the contract go? Does it disappear into thin air? Hardly. "C" buys the contract from "A" and becomes the new counter party. If the contract declines to $700 the "A" loses $200 and "C" loses $100 while "B" makes $300. – Bob Baerker Mar 24 '18 at 14:45
  • Thanks, I see it right now. So basically A can close out if and only if there is a buyer (C in your case) who is willing to buy the contract? From the textbook it sounds like closing out can be done just by entering into the opposite side of the original trade. – IgNite Mar 24 '18 at 14:52
  • This is from Options Futures and Other Derivatives: "Closing out a position means entering into the opposite trade to the original one. For example, the New York trader who bought a September corn futures contract on June 5 can close out the position by selling (i.e., shorting) one September corn futures contract on, say, July 20. The Kansas trader who sold (i.e., shorted) a September contract on June 5 can close out the position by buying one September contract on, say, August 25." – IgNite Mar 24 '18 at 14:53
  • "From the textbook it sounds like closing out can be done just by entering into the opposite side of the original trade." That's just another way of saying the same thing. Prior to expiration, you BTC and STC an existing contract from a counter party. If you don't close, you take delivery. – Bob Baerker Mar 24 '18 at 20:43
  • "This is from Options Futures and Other Derivatives... " In the case of American options, you can exercise them prior to expiry to acquire the underlying (long or short). But that's a different story from your original question. – Bob Baerker Mar 24 '18 at 20:44

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Browse other questions tagged or ask your own question.