What is the method used to unwind a position in a Credit Default Swap (CDS)?

Creating an offsetting position is the appropriate method used to unwind a position in a Credit Default Swap (CDS). This process involves entering into a new CDS contract that is essentially opposite in nature to the original position. For example, if an investor initially holds a protection-buying position on a certain reference entity, they can unwind their exposure by taking an offsetting position that acts as a protection-seller for the same reference entity.

By entering into this offsetting position, the investor effectively neutralizes their original risk without having to unwind or close out the contract entirely. This method is often employed because it allows investors to manage their credit exposure flexibly while maintaining market positions rather than needing to liquidate them outright.

Other methods of unwinding a position, such as liquidating the contract entirely or assigning it to another entity, may involve more complexities and potential costs. The choice to take a new position in a different CDS does not directly unwind the original position and could lead to increased risk rather than neutralizing it. Creating an offsetting position is therefore the most strategic and widely used approach in managing and strategically transitioning credit default swap positions.