By Mike Zaccardi, CMT, CFA ·August 08, 2023 · 8 minute read
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Buy to Open and Buy to Close are options orders used by traders. A trader buys to open using calls or puts with the goal of closing the position at a profit after the options price increases.
Investors use a “buy to open” order to initiate a new options contract, betting that the option price will go up. On the other hand, traders who want to exit an existing options contract, thinking the option price will go down, use a “buy to close” order.
What Is Buy to Open?
“Buy to open” is an order type used in options trading, similar to going long on a stock. Generally, you think the price is going to go up, which is a bullish position. That said, in options trading, you can buy to open a call or a put, and buying a put is taking a bearish position. Either way, to buy to open is to enter a new options position.
Buying to open is one way to open an options position. The other is selling to open. When buying to open, the trader uses either calls or puts and bets that the option will increase in value – that could be a bullish or bearish wager depending on the option type used. Buying to open sometimes creates a new option contract in the market, so it can increase open interest.
A trader pays a premium when buying to open. The premium paid, also called a debit, is withdrawn from the trader’s account just as the value of a stock would be when buying shares.
Recommended: Popular Options Trading Terminology to Know
Example of Buy to Open
If a trader has a bullish outlook on XYZ stock they might use a buy to open options strategy. To do that, they’d purchase shares or buy call options. The trader must log in to their brokerage account then go to the order screen. When trading options, the trader has the choice of buying to open or selling to open.
Buying to open can use either calls or puts, and it may create a new options contract in the market Buying to open calls is a bullish bet while buying to open puts is a bearish wager.
Let’s assume the trader is bullish and buys 10 call contracts on XYZ stock with an expiration date of January 2025 at a $100 strike price. The order type is “buy to open” and the trader also enters the option’s symbol along with the number of contracts to purchase. Here is what it might look like:
• Underlying stock: XYZ
• Action: Buy to Open
• Contract quantity: 10
• Expiration date: January 2025
• Strike: $100
• Call/Put: Call
• Order type: Market
A trader may use a buy to open options contract as a stand-alone trade or to hedge existing stock or options positions.
Profits can be large with buying to open. Going long calls features unlimited upside potential while buying to open puts has a maximum profit when the underlying stock goes all the way to zero. Buying to open options carries the risk that the options will expire worthless, however.
What Does Buy to Close Mean?
Buying to close options exit an existing short options position and can reduce the number of contracts in the market. Buying to close is an offsetting trade that covers a short options position. A buy to close order occurs after a trader writes an option.
Writing options involves collecting the option premium – otherwise known as the net credit – while a buy to close order debits an account. The trader hopes to profit by keeping as much premium as possible between writing the option and buying to close. The process is similar to shorting a stock and then covering.
Example of Buy to Close
Suppose a trader performed an opening position by writing puts on XYZ stock with a current share price of $100. The trader believed the underlying stock price would remain flat or rise, so they put on a neutral to bullish strategy by selling one options contract.
A trader might also sell options when they believe implied volatility will drop. The puts with a strike of $100, expiring in one month, brought in a credit of $5.
The day before expiration, XYZ stock trades near the unchanged mark relative to where it was a month ago; shares are $101. The put contract’s value has dropped sharply since the strike price is below the stock price and because there is so little time left until the delivery date. The trader profits by buying to close at $1 the day before expiration.
The trader sold to open at $5, then bought to close at $1, making a $4 profit.
Differences Between Buy to Open vs Buy to Close
There are important differences between a buy to open vs. buy to close order. Having a firm grasp of the concepts and order type characteristics is important before you begin trading.
| Buy to Open | Buy to Close |
|---|---|
| Creates a new options contract | Closes an existing options contract |
| Establishes a long options position | Covers an existing short options position |
| Has high reward potential | Seeks to take advantage of time decay |
| Can be used with calls or puts | Can be used with calls or puts |
Understanding Buy to Open and Buy to Close
Let’s dive deeper into the techniques and trading strategies for options when executing buy to open vs. buy to closer orders.
Buy to Open
Either calls or puts may be used when constructing a buy to open order. With calls, a trader usually has a bullish outlook on the direction of the underlying stock. Sometimes, however, the trader might be betting on movements in other variables such as volatility or time decay.
Buying to open later-dated calls while selling to open near-term calls, also known as a calendar spread, is a strategy used to benefit from time decay and higher implied volatility. Buying to open can be a stand-alone trade or part of a bigger, more complex strategy.
Buy to Open Put
Buying to open a put options contract is a bearish strategy when done in isolation. A trader commonly uses a protective put strategy when they are long the underlying stock. In that case, buying to open a put is simply designed to protect gains or limit further losses in the underlying stock. This is also known as a hedge.
A speculative trade using puts is when a trader buys to open puts with no other existing position. The trader executes this trade when they believe the stock price will decline. Increases in implied volatility also benefit the holder of puts after a buy to open order is executed.
Buy to Close
A buy to close order completes a short options trade. It can reduce open interest in the options market whereas buying to open can increase open interest. The trader profits when buying back the option at less than the purchase price.
Buying to close occurs after writing an option. When writing (or selling) an option, the trader seeks to take advantage of time decay. That can be a high-risk strategy when done in isolation – without some other hedging position, there could be major losses. Writing calls has unlimited risk while writing puts has risk as the stock can fall all the way to zero (making puts quite valuable).
Shorting Against the Box
Shorting against the box is a strategy in which a trader has both a long and a short position on the same asset. This strategy allows a trader to maintain a position, such as being long a stock.
Tax reasons often drive the desire to layer on a bearish options position with an existing bullish equity position. Selling highly appreciated shares can trigger a large tax bill, so a tax-savings play that also reduces risk is to simply buy to open puts.
Not all brokerage firms allow this type of transaction, however. Also, when done incorrectly or if tax rules change, the IRS could determine that the strategy was effectively a sale of the stock that requires capital gains payments.
Recommended: Paying Taxes on Stocks: Important Information for Investing
Using Buy to Open or Buy to Close
A trader must decide if they want to go long or short options using puts or calls. Buying to open generally seeks to profit from large changes in the underlying stock while selling to open often looks to take advantage of time decay. Traders often place a buy to close order after a sell to open order executes, but they might also wait with the goal of the options expiring worthless.
Another consideration is the risk of a margin call. After writing options contracts, it’s possible that the trader might have to buy to close at a steep loss or even be forced to sell by the broker. The broker could also demand more cash or other assets be deposited to satisfy a margin call.
The Takeaway
Buy to open is a term that describes when an options trader establishes a long position. Buy to close is when a short options position is closed. Understanding the difference between buy to open vs. buy to close is essential to successful options trading. These option orders allow traders to put on positions to fit a number of bullish or bearish viewpoints on a security.
Thinking about investing in options? SoFi’s options trading platform has an intuitive and approachable design that gives investors the ability to trade options either on the mobile app or web platform. Also, they can learn more by accessing the associated library of educational content on options.
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