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Sell To Open Vs Sell To Close: What The Difference?

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by Gavin in Blog
February 3, 2021 0 comments
sell to open vs sell to close

Sell to open vs sell to close is not something you want to get wrong. So today, we’ll look at exactly what the two terms mean.

Contents

With more and more experienced coaches and information available, options trading is increasingly entering the mainstream as a viable way for retail traders to make profits.

Unfortunately, unlike many other financial instruments, options contracts tend not to be very well understood.

Fundamentally, this is due to the more technical and complex nature of options compared to simpler investment vehicles such as stocks.

However, with some basic lessons, it is possible to avoid making costly mistakes.

One of the key lessons to understand is that there are four different order types that influence how an options contract is purchased or sold.

This article will explore two of those order types, being the Sell to Open and the Sell To Close orders.

Sell To Open Orders 

One of the features of options trading is that it is really simple to open a short position (i.e. a position where you profit if the value of the contract falls).

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.

With a Sell To Open order, you create a new options contract (called “writing” a contract) which another options trader will buy from you.

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).

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.

sell to open vs sell to close

With this type of contract, there are different approaches to managing the trade depending on whether it is a call or put.

Why Sell To Open?

If using a Sell To Open call option, you are aiming for the price of the underlying security to go down.

If it does, you will have two ways to make the position profitable.

The first involves simply buying back the contract – since the underlying asset has fallen in value, so too will the value of the call option you wrote.

The second way is that the holder of the option doesn’t exercise their right to buy the underlying assets, letting the contract expire worthless.

If you are instead using a Sell To Open put option, you are aiming for the price of the underlying security to go up.

If it does, the value of the contract will go down and you can buy it back at a profit before expiration.

Sell To Close 

Despite sounding very similar, the Sell To Close order is fundamentally different from the Sell To Open order.

As discussed in the previous section, the Sell To Open order is used to sell new (write) options contracts.

In comparison, the 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 call options, the value of the contract goes up if the price of the underlying stock increases, vice-versa for put options.

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.

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In that instance, you would receive the underlying stocks and you could either hold them or sell them immediately for a profit.

A simpler approach to profiting from the position (and the way in which most options traders operate) is to simply sell the option contract before expiration.

To do this, you would simply execute a Sell To Close order and your position will be closed, with the profits automatically added to your brokerage account.

This saves you from the hassle of having to buy and sell the underlying stock itself as well as allowing you to take advantage of profitable moves before the expiration date (by which time a position could reverse).

Conclusion 

A Sell To Open order is used when an options trader is seeking to make a profit from a decrease in the value of the contract (i.e. they are entering a short position).

The Sell To Open order creates a new options contract (called writing), which is bought by a different trader.

A Sell To Close order is used when you are seeking to close a position for an options contract you already own.

Trade safe!
Gav.

Disclaimer: The information above is for educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are not familiar with exchange traded options. Any readers interested in this strategy should do their own research and seek advice from a licensed financial adviser.

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Options Trading 101 - The Ultimate Beginners Guide To Options

Download The 12,000 Word Guide

Get It Now