While you must have heard the terms sell to open and sell to close, it is another thing to understand what they mean.
They are terms used often in the options market. In the options market, you can either buy or sell call options or buy or sell put options.
Regardless of which side of the trade you take, you’re making a bet on the price direction of the underlying asset. But the buyer and seller of options are seeking to profit in very different ways.
In the options market, every call option can be seen as a bet between the two parties who are trading.
The buyer is betting that the price of the underlying asset will be higher on the open market than the strike price and that it will exceed the strike price before the option expires.
If so, the option buyer can buy that asset from the option seller at the strike price and then resell it for a profit.
In this article, you would understand what sell to open and sell to close mean. In addition, the differences between the both have also been outlined.
Keep reading.
What Does It Mean to Sell to Open?
This is a term used by many brokers to denote the opening of a short position in an options or other derivatives transaction.
The opening enables the trader to receive cash or the premium for the options. The call or put position associated with the option may be covered, in which the option owner owns the underlying asset, or naked, which is riskier.
Essentially, sell to open denotes instances in which an option investor pledges, or opens, an options trade by selling or creating a short position in an option.
This enables the option seller to receive the premium paid by the buyer on the opposite side of the contract. Options are a type of derivative security.
Selling to open allows a stakeholder to be eligible for a premium as the investor is selling the opening associated with the option to another stakeholder within the market.
This puts the selling investor in the short position on the call or put, while the second investor takes the long position or the purchase of a security with the hope that it will increase in value.
The investor shorting the position is hoping the underlying asset or equity does not move past the strike price, as this allows them to keep the underlying security and benefit from the long investor’s premium.
Sell to open can be established on a put option or a call option or any combination of puts and calls depending on the trade predisposition, whether bullish, bearish or neutral, that the option trader or investor wants to implement.
With a sell to open, the investor writes a call or put in hopes of collecting a premium. The call or put may be covered or naked depending on whether the investor writing the call is currently in possession of the securities in question.
An example of a sell to open transaction is a put option sold or written on stock, such as one offered through Microsoft.
In this case, the put seller may have a neutral to bullish view on Microsoft, and would be willing to take the risk of the stock being assigned, or put, if it drops below the strike price in exchange for receiving the premium paid by the option buyer.
Read Also: How to Sell on StockX: 2022 Ultimate Guide
What Does It Mean To Sell To Close?
Sell to close shows that an options order is being placed to exit a trade. The trader by this time owns the options contract and by selling the contract will close the position.
Sell to close is employed to close a long position originally established with a buy to open order and can be likened with buy to close and sell to open orders.
It is also used, but less often, inequity and fixed-income trading to indicate a sale that closes an existing long position.
Simply put, a sell-to-close order is used when a person who has been in a long position decides to close the existing long position.
If an option is out of the money and will expire worthlessly, a trader may still choose to sell to close to clear the position.
Once a position is owned by an option trader or its derivatives, it can only be allocated in three ways:
The option is out of the money (OTM) and expires worthless; the option is in the money (ITM) and can be exercised to trade for the underlying or settle for the difference, or the option can be sold to close the position.
A sell-to-close order may be made with the option ITM, OTM, or even at the money (ATM).
Buyers or sellers will naturally sell to close call options contracts they own when they are not interested in holding a long bullish position on the underlying asset anymore.
They sell to close put options contracts they own when they no longer want to hold a long bearish position on the underlying asset.
Sell to Open vs. Sell to Close?
Even though the two terms sound alike, there are fundamental differences between “sell to open” and “sell to close”.
You must pay attention when putting in the orders to make sure you get them correctly.
Some of the differences are:
- A Sell to Open order is one in which you short sell a new options contract. That can be selling to open a call- bearish trade or selling to open a put bullish trade. Since options contracts are bought and sold on a marketplace by market participants, it means that participants can either buy/sell an existing contract or create their own. However, they sell to close order is used to sell an existing options contract that you already own and it is used for both call and put options.
- With a Sell to Open order, you create a new options contract (called “writing” a contract) which another options trader will buy from you.
- With the sell to open option, if the holder of the option chooses to exercise their right, you will be obligated to sell them the security at the strike price, regardless of what the actual price of the security is. However, with sell to close, if you had a call option and the underlying stock price increased, you could hold it to expiration and exercise your right to buy the agreed amount of underlying stocks for the agreed-upon strike price.
- In a sell to open order, there are diverse approaches to handling the trade subject to whether it is a call or put. However, for the seller to close, the value of the contract goes up if the price of the underlying stock increases, vice-versa for put options.
For both the sell to open and sell to close, when you write an option, you give the buyer of the option the right, but not the obligation, to buy the underlying security from you at an agreed-upon price (called the strike price).
Conclusion
By way of conclusion, you should note that a sell to open order is used when an options trader is looking to make a profit from a decrease in the value of the contract.
This means when they are entering a short position. The sell to open order also creates a new options contract (called writing), which is bought by a different trader.
However, a sell-to-close order is used when you are seeking to close a position for an options contract you already own. This is essentially the difference between sell to open and sell to close.
Frequently Asked Questions
They are both. To close those “sell to open” positions, you eventually “buy to close” the call or put. This strategy is known as covered call writing. You collect premium when you sell to open a call, and your risk is mitigated because you already own the stock and will be able to deliver this stock if the call you sold is acted on.
There is no perfect time to buy a stock when trading options. The opening hours are when the market factors in all of the events and news releases since the previous closing bell, which contributes to price volatility. So if you’re a novice, you may want to avoid trading during these volatile hours, or at least within the first hour.
Buy to close’ is used when a trader is net short an option position and wants to exit that open position. Traders normally use a ‘sell to open’ order to establish open short option positions which the ‘buy to close’ order offsets.
No. Some traders think that anytime you buy or sell options, you eventually have to trade the underlying stock. This is not true. You can sell to close the position, prior to expiration.
When you sell-to-close, the options you owned no longer exist. All option contracts are with the clearinghouse, not with the person on the other side of your transaction. When you bought to open your options, two contracts were created for each contract.
Yes. You can exit anytime you want, even one minute after buying, or you can hold till the expiration date.
References
- https://www.investopedia.com/terms/b/buytoclose.asp
- https://www.quora.com/What-are-the-differences-between-sell-to-open-sell-to-close-and-exercising-a-stock-option
- https://www.youtube.com/watch?v=-F-a4izgMhU
- https://mnymstrs.com/blog/buy-to-open-vs-buy-to-close-what-it-means-and-how
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