The arrested OGW was identfied as Arif Sofi of Kulgam, sources said.
Security forces have recovered an AK-47 and an INSAS rifle from the site of the encounter.
The operation which started late last night was called off after the killings.
It is learnt that a team of Indian Army officials sealed off an area in Khudwani at around 3 AM after receiving a tip off about the presence of Hizbul terrorists.
The police said the operation has ended.
Police say report of active shooter at Columbus, Ohio high school
At 8:33 a.m. on Friday, police were called to the 2900 block of South High Street in Columbus on the report of an active shooter. However, the incident has ended without injury after the SWAT team confiscated a gun at the school.
Security forces killed two terrorists in an encounter in Kulgam district, while the third terrorist surrendered.
Later at a press meet, Army, J&K Police and CRPF made a joint appeal to militants to surrender, announcing that officers who would motivate militants to drop arms would be rewarded.
The gun battle came a day after government forces killed two militants and captured another in the southern Shopian area after a day-long exchange of fire.
According to Kashmir Media Service, the martyred youth have been identified as Sayar Ahmad Wani and Dawood Illahi Khan.
Indian troops on Monday killed two more Kashmiri youth in Srinagar, the capital of Indian Occupied Jammu and Kashmir valley.