Inverse Transaction

Going into a store and not buying something. Or...maybe it involves going into a store, putting something of yours on the shelf, and then walking out.

Actually, neither of those. An inverse transaction represents a way of closing out a forward contract.

A forward contract is like a promise. You'll buy your brother's car in May for $2,000, but you can't do it now because it will take you a few months to save up the money. That deal represents a forward contract...you are buying something at a specified price at a specified point in the future.

In financial markets, these deals are used for a number of reasons. A company can lock in a price for something they will need in the future (an airline setting up a forward contract for jet fuel). Or it can be used for hedging (you have a bunch of money tied up in euro-denominated bonds and you want to make sure that changes in the euro's value don't hurt you too much). Or it can be pure speculation (you just think oil prices are going up, so you're using the forward contract to make that bet).

An inverse transaction closes out a position. Basically, you're making a loop with a bet you've already made by making the exact opposite bet.

You buy a futures contract to acquire 1,000 barrels of oil at $75 a barrel, with the contract expiring in May. An inverse transaction would involve purchasing a forward contract requiring you to sell 1,000 barrels of oil at $75, expiring in May.

It may seem like a pointless activity, setting up transactions that cancel each other out. But the value of the forward contract changes as the price of an underlying asset changes. So...you may have purchased the futures contract to buy the oil at one price. Then, when you buy the futures contract to sell the oil, you paid another price. The difference between those prices represents your profit or loss on the deal.

Using the inverse transaction, you lock in a profit. That way, you don't have to wait until May, when the contract expires.