There are 4 types of transactions whose terminology must be well understood by option traders. The terminology that must be understood is:
- Buy to open
- Buy to close
- Sell to open
- Sell to close
Buy to open
When a trader buys to open, he is effectively initiating a long position. Buy to open is also known as buy to own. It means the same thing. When a trader buys to open a call option contract, he is bullish on the underlying security’s price. On the other hand, when a trader buys to open a put options contract, although he is entering a long position on the put option contract, he is in fact bearish on the underlying security’s price.
For example, Trader A buys to open 4 call option contracts. Later, he sells to close all the 4 option contracts and makes a profit of $1000 in total.
Sell to open
When a trader sells to open, it means that he is initiating a short position. When a trader sells to open a call options contract or a put options contract, he is making a calculated bet that the options premium will decline over time such that he will be able to close out the positions(buy it back at a low price) at a profit.
For example, a trader sells to open 4 call option contracts at a price of $100 each. All of these contracts expire worthless by the end of the month. As such, the trader gets to keep a total premium of $400 without taking into account brokerage fees.
Buy to close
When a trader buys to close, he previously initiated a short position and wants to close out his positions by buying. An options trader who has had a short position on an options contract will buy it back. This way, he closes the short position. An options trader would want to short an options contract when the options premium is high and buy it back when the options premium is low. You can think of a closing transaction as a way to eliminate or reduce.
For example, Trader B buys to close 10 call option contracts at a price of $2 each. Previously, he initiated bought to open each of these 10 contracts at a price of $1 each. As a result, he loses $100 per contract. In total, the trader loses $1000.
Sell to close
An options trader who had initiated a long position on an options contract earlier would want to close out his positions by selling to close. In a very simplified example, he he bought a June 60 call option contract at $1 and sells to close that same contract at $2, he ends up with a profit of : $2 – $1 = $1 Since an option contract has 100 shares of an underlying security, his total profit is : 100 x $1 = $100
Read : Order Entry