You’ve probably heard the terms “Buy to Close” and “Buy to Open” if you’re a stock market newbie or a stock market veteran new to online trading.
Along with those phrases, you’ve probably heard “open to buy,” “sell to buy,” and “sell to close.”
They may sound like real estate terms, but these terms, particularly “Buy to Open” and “Buy to Close,” are not to be confused.
It’s critical to understand the Buy to Open vs. Buy to Close concept, as well as other stock market trading options.
Gaining a better understanding of Buy to Open vs. Buy to Close, as well as other selling options, will allow you to make better decisions on the trading floor.
This article gives a clearer view of how to trade options. It also gives a comparison between buy to open vs buy to close.
Buy to open vs Buy to Close Options
Buy to open vs buy to close options are a contract between two parties that grants them the right, but not the obligation, to buy or sell a specified amount of an underlying asset at a predetermined price (the strike price) by a predetermined date.
An option trader, like a stock trader, can go long or short (betting on the price falling). Because options involve the use of contracts between two parties that can then be traded on a market, an options trader can enter into a position in one of two ways. They are as follows:
- Buying or selling a brand-new options contract
- Buying or selling an existing options contract
This provides an options trader with more flexibility and considerations when entering a position, increasing the number of potential options with which they can trade.
There are four ways to start a business which are:
- Buy to Open
- Buy to Close
- To Open, Sell
- Sell in order to close
Buy to Open
A Buy To Open is one of two ways to open an option position (the other is the Sell To Open). It is used when a trader wants to go long the option, which means they believe the option’s value will rise.
When a trader executes a Buy To Open, he or she creates a new options contract in the market.
The cost of the option (called the premium) is debited from the trading account with this type of order, and the trader is awarded a long position in the market.
Buying to open vs. buying to close
A Buy To Open can be used to purchase both a call and a put, and it functions the same way for both.
When a Buy To Open is used for a call position, the trader is hoping that the underlying stock’s price will rise, increasing the value of the call option.
When a Buy To Open is used for a put position, the trader is hoping for the stock price to fall, which will increase the value of the option.
Remember that the Buy To Open signifies that the trader is going long with the option’s value rather than the underlying’s value.
Whether you use a Buy To Open order for a call or a put, you must buy the call or put the option back to close the position, which is done by executing a Sell To Close order.
Buy to Close
In two ways, a Buy To Close order differs from a Buy To Open order.
The first is that you are trading a position in a previously created options contract. The second difference is that the order is used when you want to close a position rather than open a new one.
Simply put, whenever a Sell To Open order (which involves the creation and sale of a call or put option) is placed, a Buy To Close order is required to close the position.
When a call or put option is sold, the trader enters a short position and receives some money upfront for creating the option (i.e. they receive an option premium).
After some time, the position may move into profit or loss, and the trader may wish to close out their position before it expires.
To do so, they would need to buy back the options that were sold, which would necessitate the execution of a Buy To Close order.
When this happens, the trader effectively pays someone else to take over the position.
The new owner of the position can then either hold it until expiration (to exercise the option or let it expire worthlessly) or close it before expiration using a similar Buy To Close order.
What Exactly Is Options Trading?
Buying and selling options in the market is referred to as options trading.
Traders can enter into a contract to create a new option or trade their positions in an existing option.
As a result, several buyers and sellers can trade options within a predetermined time frame. When the contract expires, the exchange will keep track of all changes so that the final owners have a complete picture.
It’s critical to understand that this contract comes with a cost, known as a premium. It is a set price that acts as a deposit of some kind.
The prospective buyer can use it as a down payment to secure their right to purchase at a specific price on or before the specified date.
When to Use Buy to Open vs Buy to Close
Now that you know the difference between buy to open and buy to close, you need to know when to use them.
BUY TO CLOSE: Definition And Trading Guide
When Should Investors Buy for the Long Term?
You should buy to open whenever you want to profit from a change in the price of an underlying asset. Taking buy-to-open positions can help you to hedge or offset risks in your portfolio.
It is especially effective if you use a buy to open an out-of-the-money put option at the same time you buy the underlying stock.
Overall, buying to open offers the potential for significant gains. Furthermore, even if there are losses, they will be minor.
Of course, there is always the risk that the buy-to-open position will be worthless by the time it expires due to time decay.
When Should Sellers Buy in Order to Close?
Time decay works in your favor as an option seller. Nonetheless, there may be occasions when you want to close the position before it expires.
One scenario in which this could be true is if the underlying asset’s price rises. When this occurs, buying to close may allow you to access profits sooner.
Assume you’re selling at-the-money puts on the last 12 months. The underlying asset then rises by 15% after two months. You could take advantage of the opportunity to buy to close and immediately access the majority of your profits.
Alternatively, buying to close may limit your potential losses. Let’s go back to the previous scenario of selling at-the-money puts.
However, instead of the underlying asset increases by 15%, suppose it decreases by that amount. You could decide to buy to close at this point to avoid incurring even greater losses if you wait any longer.
Conclusion
A Buy To Open order is used when a trader wants to open a new long position in which they are betting on the option’s value rising. A Buy To Close order is used when a trader wants to close an existing short position.
FAQ
What is Buy to open?
A Buy To Open is one of two ways to open an option position (the other is the Sell To Open). It is used when a trader wants to go long the option, which means they believe the option’s value will rise.
What is option trading?
Buying and selling options in the market are referred to as options trading.
What does buy to close mean?
Buy to close’ refers to terminology that traders, primarily option traders, use to exit an existing short position. In market parlance, it is understood to mean that the trader wants to close out an existing option trade.
How do I close a buy to open call option?
To close that “buy to open” trade, you eventually “sell to close” the call or put. Buying calls and puts — and subsequently selling them to close out the position — is just like regular stock trading. You can buy a stock to open a position and sell the stock to close the position.
