Square Off in Commodity Market: Meaning, Process & Importance

Square off in commodity Market Process means closing the position of the commodity trading deal prior to its expiration date. Squaring off is done through taking a position contrary to the one taken at the very beginning of the transaction in order to make some profit, limit losses, and avoid physical delivery of the commodity. It is imperative that one must comprehend square off in the commodity market process for being a trader in the commodity market.

What is Square Off in Commodity Market?

Square off in commodity market refers to closing an existing position of buying and selling the contract before the expiration date of the contract.

Some examples are as follows:

• A trader who has taken a position of buying a commodity future can square off his position through the sale of an equal contract.
• A trader who has taken a position of selling a future can square off his position through the buying of an equal contract.

The profit or loss is calculated on the basis of the buying and selling price.

How Does the Square Off Process Work?

Squaring of the position in commodity market transaction normally involves:

Step 1: Opening of the Position

Opening of either long or short position in commodity futures or option contracts by the trader.

Step 2: Monitoring Price Movement

The trader keeps a check on prices and assesses profit/loss situation.

Step 3: Placing of Reverse Order

Placing of a reverse order in order to close the position before the contract expires.

Step 4: Calculating of Gain/Loss

Determination of gain/loss by calculating the difference between the buying/selling price of opening of the contract and its closing price by the exchange.

In case the position is not squared off prior to expiry of the contract, then the contract can be settled in accordance with the rules of the exchange.

Why is Square Off Important?

There are a number of benefits of square off in commodity market.

Facilitates Booking of Profit

This allows the traders to close their trades once the profit targets have been met.

Protects from Further Losses

It prevents further losses by closing positions at the appropriate time.

No Physical Delivery

A lot of people prefer to square off their positions rather than making physical delivery of the underlying commodity.

To learn what actually takes place in case of non-squaring of positions before expiry, one can study physical delivery in commodity trading.

Helpful for Capital Management

Squaring of positions makes available the margins for other investments.

Types of Square Off

Intraday Square Off

Positions initiated during the trading period are squared off before market hours conclude.

Positional Square Off

Open positions in futures/option contracts are squared off before the contract expires.

Automatic Square Off

Some brokers square off open positions automatically when investors do not square them off within the stipulated period.

Square Off in Commodity Futures and Options

The square off in commodity market process is somewhat different for futures and options.

Commodity Futures

In futures, it is common practice that most of the futures traders square off their positions before expiry.

Commodity Options

Similarly, option holders or writers can also square off their positions prior to expiry. It is important to know about the devolvement process in commodity options as certain option positions can become futures positions if not squared off prior to expiry.

Factors to Consider Before Squaring Off

Prior to squaring off in the commodities market, some considerations to keep in mind are:

Trend in Market

Evaluate the existing trend in the market prior to squaring off. Trend may be a determining factor in squaring off at an appropriate time.

Profit Objective

Ensure that you have achieved your target profit level. This will ensure that you maintain discipline while trading.

Stop Loss Level

Squaring off the trade if your stop loss level gets hit is advisable, in order to minimize losses.

Expiry of Contract

Monitor the expiry of the contract to avoid being forced into physical delivery.

Volatility

Volatility in the market can result in sharp price movements.

Common Mistakes to Avoid

Putting Off the Decision Till the Last Minute

Putting off the decision till the last minute may raise the risks of execution. In addition, it may create some unintended consequences such as settlement or increased volatility.

Disregarding Expiry Dates

The ignorance of expiry dates may lead to physical settlement. One needs to be aware of expiry dates to make a profitable trade.

Trading Without Stop-Losses

Traders often engage in trading operations without stop-loss orders that may lead to great losses in case of a drastic change in the market.

Lack of Knowledge about Settlement Rules

The rules of settlements vary from one commodity contract to another. Knowing them will help traders make a safe trade.

Advantages of Square Off in Commodity Market

Improved Risk Management

Squaring off helps traders reduce risks by getting out of positions before any unfavorable price movement hits their capital.

No Delivery Responsibilities

With positions squared off prior to expiration, traders will be able to get out of the obligation of delivery of certain commodities.

Increased Trading Options

Squaring off enables traders to exit from existing positions and redeploy their capital into other profitable areas of trading.

Better Portfolio Management

By squaring off positions regularly, traders can review the progress of their portfolio and adjust where necessary.