How Does Canceling Out of a Futures Contract Work?

Futures traders must be aware of contract specifications.

Futures traders must be aware of contract specifications.

Trading futures gives you a chance to profit from the price changes of a wide range of commodities and financial instruments. If you're new to futures, the trading is different than with other markets, where the primary goal is to buy low and sell higher. With futures, traders can trade in either direction, allowing the ability to buy high and sell low. Keeping track of which direction makes a profit, and how to cancel a contract to lock a profit or limit a loss, is an important futures trading skill.

Understanding Long and Short

Since a futures contract can be traded to profit from a price move in either direction, the usual buy and sell descriptions are not sufficient. When a trader opens a trade to profit from an upward price move, the trade is a buy-to-open order. In trading terminology, the trader is "long" on the futures contract. To profit from a declining future price, a trade can be initiated with a sell-to-open order, resulting in a "short" position in the trader's futures account. Instead of using the terms "buying" or "selling," traders refer to a trade as going long or going short on a specific futures contract.

Cancelling a Trade

To close or cancel out a futures contract position, a trader simply enters the opposite type of trade and the contract will be removed from the trader's account. For example, if a trader is long a contract, a sell order will close the trade and the trader will no longer have a position in the contract. If a futures position is short, a buy order closes out the position. A futures broker automatically matches up opposite orders with open positions. So a buy order for a specific contract will automatically close a short position if the trader has that position open. An account cannot have short and long positions in the same futures contract open at the same time.

Last Trading Day

Each type of futures contract trades several different contracts with different expiration dates. For each specific contract and date there is a designated last trading day. The last trading day may be several weeks before the contract terminates. If a trader does not close out a futures position in time she might be liable for fulfilling the contract, either delivering the underlying asset for a short position or buying the asset for a long position. The different types of futures each have its own last trading day dates and expiration dates. A trader must ensure she closes or rolls a contract to a future date before the last trading day.

Unexpected Situations

There are stories of futures traders missing the last trading day and trying to figure out what to do with 5,000 bushels of corn or 1,000 barrels of oil. Even if a trader misses the last trading date and has an obligation to complete the requirements of the futures contract, it will not be necessary to deliver or take delivery of a large and expensive amount of the underlying commodity. A trader who misses the last trading date should immediately contact his futures brokerage firm and explain the situation. The futures broker will find a way to work the trader out of the contract. It might cost some money, but not as much as fulfilling the obligations of the futures contract.

About the Author

Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.

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