What Is an Offset? Definition, Example, and How It's Used

What Is an Offset?

An offset is a financial market strategy that requires a trader to take an opening position and then take a directly opposite position. For example, if you are long 100 shares of XYZ, selling 100 shares of XYZ would be the offsetting position.

An offsetting position can also be generated through hedging instruments such as futures or options. In the derivatives markets, to offset a futures position a trader enters an equivalent but opposite transaction that eliminates the delivery obligation of the physical product that it represents.

The goal of offsetting is to reduce an investor's net position in an investment to zero so that no further gains or losses are experienced from that position.

In business, an offset refers to the generation of gains in one business unit that makes up for losses in another unit.

How an Offset Works

Offsetting is used in several types of businesses. Its effect is to remove or limit liabilities.

• In accounting, an entry can be offset by an equal but opposite entry that nullifies the original entry. For example, a loss in one division can be eliminated by an equal profit in another division.
• In banking, the right to offset provides financial institutions with the ability to seize debtor assets in the case of delinquency.
• For investors in the futures market, an offsetting position eliminates the need to receive physical delivery of the underlying asset or commodity by selling the associated goods to another party.

Offsetting Losses

Businesses may offset losses in one business division by reallocating gains from another. This allows the profitability of one activity to support the other activity.

For example, a business that is successful in the smartphone market may decide to produce a tablet as a new product line. The profits from smartphone sales can help offset the early losses associated with expanding into a new arena.

Similarly, companies with global sales may offset losses in one currency with gains in another. One unit may have risk exposure to a decline in the Swiss franc compared to the euro, while another may benefit from a declining franc.

Offsetting in Derivatives Contracts

Investors offset futures contracts and other investment positions to remove themselves from any associated liabilities. Almost all futures positions are offset before the terms of the futures contract are realized. Even though most positions are offset near the delivery term, the benefits of the futures contract as a hedging mechanism are still realized.

A futures contract is an agreement to purchase a particular commodity at a specific price on a future date. If a contract is held until the agreed-upon date, the investor could become responsible for accepting the physical delivery of the commodity in question.

The purpose of offsetting a futures contract on a commodity, for most investors, is to avoid having to physically receive the goods associated with the contract.

Offsetting to Reduce Risk

In the options markets, traders often look to offset certain risk exposures, sometimes referred to as their "Greeks." For instance, if an options book is exposed to declines in implied volatility (long vega), a trader may sell related options to offset that exposure.

Or, if an options position is exposed to directional risk, a trader may buy or sell the underlying security to become delta neutral. Dynamic hedging (or delta-gamma hedging) is a strategy employed by derivatives traders to maintain offsetting positions on an ongoing basis.

The Bottom Line

If the initial investment was a purchase, a sale in the same amount is made to neutralize the position. To offset an initial sale, a purchase is made to neutralize the position.

With futures related to stocks, investors may use hedging to assume an opposing position to manage the risk associated with the futures contract. For example, if you wanted to offset a long position in a stock, you could short-sell an identical number of shares.