What is an Offsetting Transaction?
An offsetting transaction is a transaction that cancels out the effects of another transaction.
How Does an Offsetting Transaction Work?
Offsetting transactions are common in options and futures markets. For example, let's say John Doe sells an option to buy 100 shares of Company XYZ with a strike price of $20 per share. The option expires in one year. Because John is locked into the contract, he cannot just ignore it. So, he enters into an offsetting transaction by buying an identical opposite transaction (buying an option to sell 100 shares of Company XYZ with a strike price of $20 that expires in one year). This offsets the risk he bears with the first option.
Why Does an Offsetting Transaction Matter?
Offsetting transactions are risk-management tools, and investors and companies use them when they cannot simply cancel the original transaction. In the derivatives markets, this happens when investors cannot accept a delivery of thousands of pounds of coffee from a futures contract, for example.