When trading options, traders acquire the right to buy or sell an underlying stock at a specific price, known as the strike price, before the option expires. However, the terminology for buying and selling options is not as simple as when trading stocks. Options traders must choose between Sell to Open vs. Sell to Close, Buy to Open vs. Buy to Close. In the article, we will consider the fidelity of these conclusions and explain what Buy to Open vs. Buy to Close is and consider their features.
What is Buy to Open?
Buy to Open means opening a new long call or a put position in options. If a trader wants to buy a call or a put option, they must Buy to Open vs. Buy to Close. An open order shows other market participants that the trader is opening a new position and not closing an existing one.
Buy to Open is an order used to demonstrate taking a long position. If a trader wants to purchase a call or put options, they can open a Buy to Open order. This order tells the market that the trader is opening a new long position rather than a new short position or closing an existing one. To open a new short position, they would use a Sell to Open order; to close an existing long position, they would use a Sell to Close order.
The trader needs to pay the option premium to buy the right to open the long or short position in the underlying security, and this amount is immediately debited from the trader’s account. The underlying security’s price needs to rise enough to make a profit from a Buy to Open call option (vs. Buy to Close) to surpass the break-even point; a bullish strategy should be implemented. To close the options trade, the trader has to use a Sell to Close trade order to sell the call or put options back.
Note! When trading stocks, you only need to place a buy or sell order on time.
Example of Buy to Open
Let’s look at an example of a Buy to Open trade to understand better how it works. Suppose an investor named John wants to initiate a Buy to Open trade in options trading; he must follow the steps listed below:
Step 1: The trader, John, must first identify the type of option he wants to buy. He would consider the market volatility and assets reliability to anticipate profit over the trade.
Step 2: Depending on his outlook for the underlying asset, he must decide between a call option or a put option. A buy call option strategy is used if the trader is anticipating a bullish pull to follow the price trend. Conversely, a bearish viewpoint on an asset allows traders to use put options to get profits.
Step 3: John must then locate the best bid and ask for prices for the option he wants to buy. He can access these prices through a broker or an online trading platform like Fidelity.
Step 4: John must then order to buy the option at the best available price. It is known as a Buy to Open order. If the order is filled, John has now opened a Buy to Open position in options trading.
Step 5: John can now manage his position by monitoring the market and deciding when to close the position. He can close the position by reselling the option to a new buyer using the Sell to Close feature.
What is Buy to Close?
Buy to Close is a term used in investing, specifically related to options trading. It describes closing out an existing position in an option by buying an offsetting option contract. In other words, when a trader has an open option short position and wants to close it, they would execute a Buy to Close order vs. Buy to Open. It allows the trader to realize any potential gains or losses on the position, depending on the options’ current value relative to when it was opened.
Example of Buy to Close
Let us assume a trader has opened a short-call contract and wishes to secure a profit or accept a slight loss if they anticipate the underlying asset’s price will continue to increase. They can close out the options contract before the expiration date.
A short-call order demonstrates that the trader has sold the contracts at a high price with the expectation that they would buy the same ones at a lower price to compensate for the number of contracts in the market and get a profit during this trade. Therefore, the trader must buy the short calls initially written to close his position. The process is termed Buy to Close.
Let us look at a different scenario using actual trades. Suppose an options trader operated an opening position by selling one put contract at a strike price of $50 of ABC stock. The investor anticipated that the value of the underlying stock would rise, as indicated by the bullish outlook of its price motion. Whenever an option is sold, a premium is received for selling a contract.
Otherwise, a premium price has to be paid to secure a position while buying a contract. In this case, an $4 premium is credited to the investor for writing a short put. Before the expiration date of the contracts, the price of the stock ABC is $51. The trader can choose to sell the position before it expires by paying a premium of $1 because the price movement was similar to investors’ anticipation. The net profit generated during this trade equals $4 as $5 was credited during the opening, and $1 was debited during the closing position.
Understanding Buy to Open and Buy to Close
Buy to Open vs. Buy to Close is an exciting concept every options trader must master to develop profitable trading strategies.
Buy to Open
Depending upon a stock’s prospects, a trader can decide to open a call or put orders. Buy to Open call options trading is a strategy that involves buying options with the intent of making a profit if there is a bullish run.
Suppose the underlying asset price rises above the strike price before the expiration date. In that case, the trader can exercise their option and buy the underlying asset at the strike price, thus profiting from the asset price rise.
Buy to Open Put
Buy to Open Put options trading is a strategy that involves buying a put option contract on a stock or other underlying asset. Put options give the investor the right to sell the underlying stock at a pre-established price on or before an expiration date.
Buy to Open Put options contract is used when the investor forecasts that the underlying stock price will decrease. It is also used to hedge against potential losses on a long position in the underlying asset, commonly known as the protective put strategy.
Buy to Close
Buy to Close is a type of order placed with a broker to close an existing position in a security. It is typically used when closing a short position in an option or stock. This action can decrease open contracts in the options market, while buying to open can increase available contracts.
Shorting Against the Box
Shorting against the box is an options trading strategy that involves simultaneously buying a put option and selling a call option on the same stock or underlying asset. It is typically used when an investor believes that the underlying stock’s price will remain stable over a period.
This strategy is used to lock the value of an asset without selling the actual stocks; this prevents the taxation on potential profits. The investor opens a position for a particular stock, followed by borrowing identical shares and then selling the borrowed shares. Traders use this investment tactic to lock gains until their short position is closed; this helps the profit to be unrecognized for tax reasons.
What is Buy to Open vs. Buy to Close?
Buy to Open vs. Buy to Close are options trades that allow investors to buy or sell options contracts. Buy to Open is when a trader buys an option contract and opens a long position. Buy to Close is when a trader closes a short position by selling an option contract.
A trading strategy should be implemented, using puts vs. calls in long or short options positions. Buy to Open trades are implemented to gain profits from fluctuation in the underlying stock. Conversely, a Buy to Close trade is executed to gain the advantage of the time delay.
The difference between Buy to Open and Sell to Open
Buy to Open indicates a long position in which the trader holds an option on the account and seeks to profit from its value growth. Sell to Open when a trader has made money from selling an option and is waiting for the option to lose value, vs. Buy to Open.
The difference between Buy to Close and Sell to Close
Sell to Close is an order to sell options. It is needed to exit the trade and close the existing long position. When you Sell to Close, you receive the amount after the close of the trade, which is usually more significant vs. the amount you paid when you entered a Buy to Open trade.
Differences between Buy to Open and Buy to Close
When investing in options trading, one may open a new position or close an existing one. For options traders, it is vital to understand the circumstances under which to use Buy to Close vs. Buy to Open operations.
Trade must be open before it can be closed. You can enter a trade by buying or selling options and later compensate by closing the trade by selling or repurchasing the contracts. The price difference between the sequential opening and closing trade leads to gains or losses.
The main difference between Buy to Open and Buy to Close is the purpose of the transaction. Buy to Open is used by options buyers to initiate a long position in the market, vs. Buy to Close is used to close an existing position.
Buy to Open involves buying the security with the expectation of a price increase, i.e., long position, vs. Buy to Close applies to selling the security with the expectation of the price decreasing, i.e., short options position. Both can be used with call and put options.
The bottom line
In conclusion, the decision to use Buy to Open vs. Buy to Close in options trading depends on the trader’s objectives. Buy to Open is a typical approach when a trader predicts an increase in the underlying stock price. On the other hand, Buy to Close is used when a trader anticipates that the stock price will decrease. The decision on what to use, Buy to Close vs. Buy to Open, should be taken carefully, as the wrong one can lead to significant losses.