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What does “buy to open” or “buy to close” really mean?
What are the essential elements you should know!
In this article, we will break down the financial definition of Buy To Open vs Buy To Close so you know all there is to know about it!
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Difference Between Buy To Open vs Buy To Close
What Are Options
An option is a contract between a buyer and a seller where a party has a right (but no obligation) to buy or sell an underlying asset, at a set price, by a certain date.
Just like stock investments, a trader can purchase options by going long or bet on falling prices by taking a short position.
In the options market, there are four different ways an options trader can trade options:
- Buy a call option
- Sell a call option
- Buy a put option
- Sell a put option
An experienced trader may combine different trades and investment strategies to generate profits.
When trading options, the investor or trader is looking to earn a profit by predicting the direction in which the underlying stock, security, or asset will go.
Option Trading Terms
In options trading, there are different terms and lingos used to refer to when a person is buying or selling options, namely:
- Buy to open
- Sell to open
- Buy to close
- Sell to close
What Is A Buy To Open
The term “open” refers to the fact that a person is taking a new position in a trade (acquiring options).
This means that you can go long on a call option or long on a put option.
What Is A Buy To Close
“Buy to close” refers to an options trader (seller) who is looking to close out an already existing trade position.
The term “close” means that the trader is looking to close an already open position.
If an option seller sold put or call options, it has taken a short position on the underlying stock.
To close the short position, the same option contract must be purchased (hence “buy” to “close”).
Buy To Open vs Buy To Close Financial Definition
What does buy to open vs buy to close mean?
How do you define these options trading terms?
According to Investopedia, buy to open is defined as:
“Buy to open” is a term used by brokerages to represent the establishment of a new (opening) long call or put position in options.
On the other hand, buy to close is defined as:
‘Buy to close’ refers to terminology that traders, primarily option traders, use to exit an existing short position.
Essentially, both ‘buy to open’ and ‘buy to close’ are options trading terms used by brokerage firms, investors, and traders referring to a long call or put position in options or the closing of a short position by a trader.
Why Buy To Open or Buy To Close
Why Open A Position
To “open” a position means that an investor or trader purchases a call or put option (taking a long position).
As such, if an investor wants to purchase a call option or put option to acquire an interest in an option contract, it must “buy” for the purpose of “opening” a position.
When a trader initiates a long option position, he or she can take advantage of the underlying stock price movements (or volatility) to earn a profit.
Essentially, a buy to open is one of two ways a trader can open a position in options (the other method is sell to open).
An investor can open a position in a new call option contract (to take advantage of the underlying asset price going up) or a new put option contract (to take advantage of the underlying asset price going down).
Why Close A Position
To “close” a position means that an investor wants to sell an option or close a short position.
This means that you are closing a position or a trade that you’ve made before.
Also, to close a position means that you are looking to put an end to an open position that you’ve taken.
To “buy” an option to “close” means that the options seller wants to buy options to close an open contract or a trader wants to buy to close a short position.
For instance, if a sell to open was initially placed, a buy to close will be required to close out the trade position.
This means that an options trader at some point sold a call or put options placing it in a short position.
To close this position, the option seller will need to buy back the options by placing a buy to close order.
Buy To Open And Buy To Close Examples
Let’s look at an example of when an investor would buy to open or buy to close.
Buy To Open Example
Mary is an options trader.
She considers that the Company ABC stocks can increase in price over the next few weeks.
As a result, she decides to purchase call options on the Company ABC stock.
In this case, Mary will buy to open a long call option position.
Buy To Close Example
Imagine that John is a proficient options trader.
He thinks that he can earn some money by selling some put options on the Company XYZ stock.
As such, he sells a put option contract on the options market.
However, before the expiration of the put options, John wants to close his put option position as he no longer wants to remain obligated under the options contract.
As a result, John decides to buy put options to close his position.
Buy To Close vs Buy To Open Takeaways
So, what does Buy To Open vs Buy To Close mean?
Let’s look at a summary of our findings.
Buy Open vs Buy Close
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