A trader liquidates a position when an existing position is converted to cash. In the futures market, there are three means to close or liquidate a futures position: delivery, offset or reversing trade, and exchange-for-physicals.
Delivery allows completion through cash settlement where traders execute payment at expiration of the contract to settle any gain or loss. The vast majority of contracts are closed via other means of delivery or cash settlement.
Offset or reversing trades occur when the trader executes a trade in the futures market to balance the net futures position to zero or flat. The majority of futures contracts are closed or liquidated through offset or reversing trades. Exchange-for-physicals (EFP) is a third way to close a position.
In an EFP, two traders agree on the price of the physical commodity and agree to cancel of their futures and then proceed to take or make the delivery of the commodity. A position may also be liquidated by a broker if the customer or trader fails to meet a margin call. Every participant on the exchange is required to recognize the day’s gains and losses on trades.
If the amount of a loss in a customer’s account falls below an initial margin requirement, a margin call is issued by the futures commission merchant. The trader must supply enough funds to meet or exceed the initial margin requirement; if this is not met, then the futures commission merchant may liquidate the positions to cover the margin call.