Table of Contents Show
- What is Sell to Open?
- What is Sell to Close?
- What is an Options Trade?
- What are the 4 Types of Options Trade?
- Tips on How to “Sell to Open” or “Sell to Close”
- A Realistic Example of Sell to Open and Sell to Close
- Some Benefits of “Sell to Open”
- “Sell to Open” vs. “Sell to Close” | What is the Difference?
- Some Other Trading Concepts and their Meaning
- Frequently Asked Questions on “Sell to Open” vs. “Sell to close”
You should be conversant with selling to open and selling to close as a trader. But if you’re questioning what sell to open and sell to close means in this contest, it’s safe to presume you’re a beginner trader or thinking about getting into it.
You’ve probably overheard a group of traders discussing sell-to-open strategies. Relax; you’re here, which is the first and most crucial step in learning something new.
This article will buttress not just the meaning of the terms but will explain in-depth the difference between both while providing a well-thought-out summary of all that is to know on sell to open and sell to close.
What is Sell to Open?
Sell to open is a term brokers and dealers often use in the financial industry. It is frequently referred to be a clear directive to short-sell an option contract.
In other words, since options contracts are bought and sold on a marketplace by market players, all indicate that individuals can either purchase or sell an existing contract or make their own.
Relax, it’s okay not to understand it now but keep reading; I assure you that before the end of this post, you’ll have a clear understanding of what it means.
What is Sell to Close?
You guessed it: the sell-to-close is simply another phrase similar in meaning but indirectly opposite to the sell-to-open.
As you may know, the sell-to-open call is used to sell new (write) options contracts, whereas the sell-to-close call is used to sell an existing option contract that you most likely hold.
This is also applicable to both the “call” and “put” options. To put it another way, when you sell to close, you are selling the contract to buy an underlying asset at a specific price (the strike price) before the expiration date.
What is an Options Trade?
Options trading is the act of buying and selling options on the market. Traders can enter into a contract to create a new option or trade their position in an existing option.
As a result, a large number of buyers and sellers can trade options within a certain time limit. The exchange will record all changes so that when the contract ends, the final owners have a comprehensive picture.
It’s crucial to recognize that this contract contains a premium price. It is a set charge that serves as a deposit of some sort.
It might be used as a down payment by a prospective buyer to protect their right to purchase at a given price on or before the designated date.
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What are the 4 Types of Options Trade?
Investors in options trading enter into contracts to purchase and sell equities at a set price within a specified time frame.
Many stocks, as well as certain exchange-traded funds, have options trading available. In the options market, there are only four fundamental positions to trade: You can buy or sell call options, as well as put options.
Options traders can initiate a new position by either buying or selling. Existing positions are closed by either selling or purchasing.
The four positions of an options trade are
- Buy a call Option
- Selling a call option
- Buying a put option
- selling a put option
Tips on How to “Sell to Open” or “Sell to Close”
Every option is essentially a contract or a wager between two persons. In the case of call options, the buyer is speculating that the underlying asset’s price will be higher on the open market than the strike price—and that it will be higher than the strike price before the option expires.
If this is the case, the option buyer can acquire the asset from the option seller at the strike price and then resell it for a profit.
A call option buyer must pay an upfront price for the right to perform that transaction. The premium is paid upfront to the seller, who is wagering that the asset’s market price will not be greater than the price indicated in the option.
In most simple options, the premium is the profit the seller is after. It is also the option for the buyer’s risk exposure or maximum loss. The premium is a proportion of the potential trade size.
A Realistic Example of Sell to Open and Sell to Close
We recognize that, in principle, options trading may appear complex and difficult to grasp. Here is a possible scenario for a real-life example to assist you in understanding the concept of options trading, especially buying or selling to open (call options) and buying or selling to close (put options).
Assume you wish to purchase 10 Tesla stocks. For the sake of clarity, we shall round the sums to the nearest round figure. Tesla stock is worth $600 per share in March 2021.
If you checked the share price six months ago, you’d notice that it was $400 in September 2020.
If you look back a year, the share price in March 2020 was $100. Given the growing curve, suppose you anticipate the price will rise in the future and that it will reach $1,000 on (or before) March 31, 2022.
Here are Some Scenarios that May Occur and the Actions You Could Take:
Buy to open: Create (open) an option contract by purchasing 10 Tesla stocks at the present price but with the strike price set at $1,000 to obtain the right to sell them at the $1,000 strike price any time before or on March 31, 2022, even if the actual price does not reach that level.
Sell to open: If the share price of Tesla’s stocks hits $1,500 in, say, six months, you may sell your ten stocks at that point to someone else for $1,000 and still remain in the game.
In this situation, you hope that the price will fall significantly before the contract’s expiration date, allowing you to exercise your right to buy them out from the broker at a lower price. Even if it does not fall, you will be forced to acquire the stocks at a higher price.
Buy to close: If March 2022 arrives and the price is still more than $1,000, you can fulfill your contractual duty by purchasing those 10 shares at the current price and completing the contract. This eliminates the possibility of the price rising much more in the future.
Sell to close: If the share price stays below $1,000 on March 31, 2022, you will still be able to sell them at that price to close the contract and profit.
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Some Benefits of “Sell to Open”
When you use a Sell To Open call option, you want the underlying security’s price to fall. If it occurs, you will have two options for turning the position profitable.
The first alternative is to simply purchase back the contract; if the underlying asset’s value falls, so will the value of the call option you wrote.
The second possibility is that the option holder does not exercise their right to purchase the underlying assets, causing the contract to expire worthlessly.
Instead, if you use a Sell To Open put option, you want the underlying security’s price to rise.
If it does, the contract’s value will fall, and you will be able to repurchase it at a profit before it expires.
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“Sell to Open” vs. “Sell to Close” | What is the Difference?
The term “sell to open” refers to a trader (the option’s initial buyer) selling a put or call option. A trader (the original buyer of the option) who sells a call or put option to close out a contract is referred to as a “sell to close.”
In other words:
Selling to open implies that you are selling an existing option: You will be paid immediately, and the buyer will retain that option, but your position within the contract will remain open if the buyer acts on it before the contract’s expiration date.
Selling to close implies that you are selling the contract to another party: You already purchased the options and are now selling them to someone else in order to get out of the deal.
When you sell to open, you are trading an existing amount of shares that you previously purchased, but you remain a contract participant. When you sell to close, you are selling your share of the contract and closing it down.
Some Other Trading Concepts and their Meaning
Knowing what a sell-to-open and sell-to-close signify isn’t enough. Trust me; trading is a lot more serious than you think.
To get better at it, you should be familiar with several strategic principles that can have a severe influence on your options trading if not handled properly. Some of the principles are as follows:
Concept of Volatility
Our concept is critical in this sector. This is a trading concept that, if not handled correctly, can lead to a very bloody leak in your pockets that may be difficult to patch up.
Now that the emphasis has been properly laid, it is safe to conclude that implied volatility is a measure of a security’s expected price movement over a given period.
The implied volatility looks forward and attempts to forecast how volatile security will be in the future. Option prices are often higher when implied volatility is high.
This is due to the increased likelihood that the underlying security may make a significant move during the term of the option contract.
Some factors can affect this concept, such as:
- geopolitical events,
- data release,
- economic announcements.
Probability of Success
There are tools available to determine the likelihood of success of your trade before you enter it. Brokers often give these tools, and they are simple to use.
The greater the likelihood, the smaller the prospect of profit. However, the smaller the probability, the greater your possibility of profit at the end of the trade.
This concept is as simple as it appears. It revolves around the time element, which you can regard as a critical consideration in trading.
It is the amount by which an option’s value decreases over time. Similar to the conventional idea of an item’s value degradation, the closer it comes to expiration, the faster it loses value.
However, this principle may sometimes work in your favor, especially when selling options. This is because when you sell a writing option, you will earn an initial premium that will gradually diminish as the option approaches expiration.
In Money Option
It is vital to highlight that there are no intrinsic values in the option of money, but it might have an extrinsic value.
Being “in the money” signifies that your option has intrinsic value since the underlying security’s price is more than (for a call) or less than (for a put) the strike.
Out-of-the-money options have strike prices that are greater than or less than the current market price for call options or less than the current market price for put options.
On the other hand, out-of-the-money options can be advantageous since they frequently have a lesser premium than in-the-money options. This implies you might sell your option for a profit even if it never hits its strike price; it only needs to get closer.
The intrinsic value of an option is the amount by which it is in the money. It is the difference between the underlying asset’s price and the option contract’s strike price.
If the underlying asset is trading at $50 per share and the strike price of a call option is $45, the intrinsic value of that option is $5.
Extrinsic value is the part of an option’s price that is not due to its intrinsic value. It is also known as a time premium since it decreases as the expiry date approaches and finally reaches zero on the expiration date.
As the expiry date approaches, time decay accelerates.
Frequently Asked Questions on “Sell to Open” vs. “Sell to close”
Q1. When Should Investors Sell to Open?
You can sell to open if you wish to profit on a change in the price of an underlying asset by getting an option’s premium.
Q2. Is Trading Options Good for Beginners?
Options trading is more complicated than stock trading and requires margin accounts. As a result, simple options methods may be suitable for certain beginners, but only once all dangers and how options operate are grasped.
In general, less-experienced traders should utilize options to hedge existing holdings or to take long positions in puts or calls.
Q3. Can I Lose Money Buying a Call?
If you purchase a call, the breakeven price is the strike price plus the premium (i.e., the price) paid for it.
So, if a $25-strike call is trading at $2.00 while the company is trading at $20, the stock must gain over $27.00 before expiration to break even. If not, the trader will lose up to the contract’s value of $2.00.
Now you know the difference between Sell To Open vs. Sell To Close. If you have any questions, please send us an email or post a comment below.
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