Whether you are a stock market newbie or a stock market veteran new to online trading, you’ve probably heard the term “Buy to Close” and “buy to open.” Along with those terms, you’re also probably familiar with “open to buy,” “sell to buy” and “sell to close.”
They sound like real estate terms but these terms, particularly “Buy to Open” and “Buy to Close,” are terms you don’t want to mix up. It’s important to understand the Buy to Open vs. Buy to Close concept, as well as other trading options in the stock market.
Gaining more insight on Buy to Open vs. Buy to Close, and other selling options, will help you make better decisions on the trading floor.
First Things First: What are Options?
Essentially, “options” are contracts between a seller and buyer. This contract enables traders to buy or sell shares at the agreed price. Traders have the right to do so, but not the obligation.
Think of it this way: an option is like a bet between the seller and the buyer. They are making a bet on the direction the price will take in the future.
For example, a buyer thinks that self-driving cars will cost less than traditional vehicles a few years from now (let’s say five years). The seller, however, begs to differ. To settle the debate, the buyer and seller create an options agreement that will give you the right (or the option) to buy or sell a car at an agreed price on a specified date.
Options are the core of the Buy to Open vs. Buy to Close and Sell to Open vs. Sell to Close argument. Since options involve using contracts to trade on a market, there are two different ways that a trader can decide on their position:
- Buying or selling an existing options contract.
- Buying or selling new options contracts.
These options give traders flexibility and more considerations when deciding on their position. There are four ways to enter a trade:
- Buy To Close
- Buy To Open
- Sell to open
- Sell to close
“Buy to Open vs. Buy to Close” Explained
When you buy, you can either open or close. They might seem a bit similar in terms of processes but it’s important to know the circumstances if you should Buy To Close or Buy To Open.
What is a Buy to Open?
When you Buy To Open, you’re opening a position as you enter the trade. Therefore, Buy to Open means a trader is willing to buy an option so they can open a position.
A Buy to Open order is handy when you want to buy a long put or a new long call. This can refer to other market traders that have potential in the market, especially if you’re placing a large order. But if you’re making a small order, others might think that you’re using a Buy to Open order for hedging or spreading.
Traders also use Buy to Open when they prefer to go long-term with their option, which means they believe the option’s value will increase over time. When they execute the Buy to Open option, they create new options contracts in the market.
There are two ways to use the Buy to Open option: you can either use it for a call position or a put position. If you use this Buy to Open option for a put position, this means the trader is expecting the stock’s prices to fall, which increases the price of the option. On the other hand, if a Buy to Open option is used for a call position, the trader is waiting for the underlying stock’s prices to rise so that the call option’s values increases.
In terms of costs, the cost of a Buy to Open option (also called a premium) is paid from the trading account. Once the payment has been debited, the trader receives a long-term position in the market.
In a nutshell, Buying to Open means that you are creating or opening a new option. You pay the premium now to secure your position.
What is a Buy to Close?
There are two ways a Buy to Close differs from a Buy to Open order. First, you are using an order when you want to close the position instead of opening another one. Second, you are trading a position with a previously created option.
Whenever a trader places a Sell to Open order (which involves the creation and sale of a put or a call option), they must also place a Buy to Close option to close their position. Once the trader sells the put or call option, they end up in a short position, which earns them funds for creating the option premium.
After some time, the position will either gain profit or lose money. The trader has to decide if they want to close their position before it expires or not. If they do, they’d have to buy back the options they sold, which require the execution of a Buy to Close order. The trader has to pay another person to take over the position.
The new trader who holds the position can use it to expire or repeat the cycle of closing the position before it expires. This prevents them from experiencing a financial crisis.
“Sell to Open vs. Sell to Close” Explained
The easy explanation for the differences between the two is if you want to “Sell to Open,” you are interested in selling a call or put option. On the other hand, if you want to “Sell to Close,” you plan to sell a put or call option to close out a contract.
Here’s a more detailed breakdown of both options.
What is a Sell to Open Order?
Trading options make it easy for traders to open a short position. With a Sell to Open order, you can short sell your new options contracts. This can involve selling to open a put (bullish trade) or selling to open a call (bearish trade).
Since market participants can buy and sell options contracts on the marketplace, they can either create their contract or buy/sell an existing contract. With a Sell to Open order, you can create a new contract, which other traders can buy from you.
When you write an option, you give a trading buyer the right (but not the obligation) to buy the security upon at a strike price (aka the agreed-upon price). If the option’s holder chooses to uphold their rights, you must sell them the security at the agreed-upon price, regardless of the actual price’s security.
Sell To Open is a great option if you want the price of an option’s security to go down. If it does, you have many ways to make a profitable sale. First, you can buy back your contract since its value has dropped. Another way is if the option holder doesn’t buy the underlying assets, which results in contract expiration.
If you are using a Sell To Open, you want the underlying security’s price to go up. If it does, the contract’s value will go down and you can buy it back before the expiration date.
What is a Sell to Close Order
Sell To Close orders sell your existing options contract. You can also use this order for both put and call options.
If you are putting an order for call options, a contract’s value will only go up if the underlying stock’s price increases. The same concept applies to put options. If you own a call option and the price of the underlying stock increased, hold on to it until it expires then exercise your right to buy the strike price.
Another simple approach to profiting from a Sell To Close order is to sell your contract option before its expiration. All you have to do is execute your order and close your position. The profits will automatically be added to your brokerage account.
This spares you from the hassle of buying and selling the underlying stock. You will surely make a profit!
Everything sounds too technical from the start so it’s OK to feel a bit overwhelmed. But in the world of stocks and trades, knowledge is power. Whether you are new to the Buy to Open vs. Buy to Close debate or need more information on financial concepts, you have to do research before you venture into this financial pursuit.
