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Sometimes referred to as an offset or an even up, a close out involves the reduction or termination of a current position on a given investment. At the same time, the investor will make an opposite transaction using the same underlying security. In effect, the outcome of the close out strategy is to maintain the amount of investment, but possible position the investor to realize a greater return from the underlying security.
One of the easiest ways to understand the function of a close out is to apply the strategy to a futures contract. In effect, the owner of a futures option may choose to get out of the existing contract by taking out a contract to sell the futures. Once a buyer for the contract has been secured, the investor is free to enter into another futures contract with more agreeable terms, but still associated with the same underlying security.
As far as the utilization of resources, the goal of the close out is to maximize return while minimizing the amount of investment necessary to secure the return. Thus, if the investor comes across an option that will produce better results for less investment, he or she will take steps to fulfill the terms of the current option and then proceed to secure the new option.
The close out will involve making a change in the long or short position associated with an investment involving the security, while at the same time committing to an opposing position with a new investment that is built on the same security. In other words, the investor may choose to reduce or eliminate a long position and create a new transaction using a short position that is based on the same security. If both the original and the new position perform within the expectations of the investor, the activity will result in a greater return. However, a close out is not a sure thing by any means. In the event that the underlying security experiences a downturn for some reason, the investor could stand to lose more money from the closeout than if he or she had simply maintained the original position.
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