The most common way to offset a futures contract is to execute an opposite trade before the delivery date.
Here's a breakdown of how it works:
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Understanding Offset: Offsetting a futures contract simply means neutralizing your position. You do this by taking an equal and opposite position to the one you currently hold.
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The Process:
- Initial Position: Let's say you initially bought (went long) one futures contract for corn. This means you're obligated to take delivery of corn at the contract's expiration.
- Offsetting Trade: To offset this, you would sell (go short) one corn futures contract with the same delivery month.
- Net Result: By having both a long and a short contract for the same commodity and delivery month, your obligations cancel each other out. You are no longer obligated to take delivery, nor are you obligated to deliver.
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Example:
- You buy 1 contract of July Wheat futures.
- Later, you sell 1 contract of July Wheat futures.
- You have now offset your position.
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Why Offset? Most participants in the futures market are speculators or hedgers, not actual producers or consumers of the underlying commodity. They generally don't want to take or make delivery of the physical commodity. Offsetting allows them to profit (or loss) from price movements without the hassle of physical delivery.
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Settlement: When you offset your position, your broker calculates the difference between the price at which you initially entered the contract and the price at which you offset it. This difference, minus commissions and fees, is either credited to or debited from your account.
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Alternative to Offset: Delivery. While offsetting is the most common method, you can also choose to take or make delivery of the underlying commodity if you are set up to do so and this is what you want.
In summary, offsetting a futures contract involves making an opposite trade to your original position, thereby canceling out your obligation and settling the profit or loss.
