Sell to Open and Sell to Close: How It Works in Options Trading
In options trading, sell to open is an order that involves selling or shorting an option to start a new transaction. It's also known as "going short" or selling short." Some investors can use this strategy when they think the price of the underlying asset will decrease and hope to profit from it.
Keep in mind that options trading involves significant risks, especially selling short strategies, and it is not suitable for everyone. This strategy has the potential for unlimited losses and is only appropriate for traders with high risk tolerance and experience.
What is Sell to Open
Both call and put options can be used with "sell to open" orders. For a call, a sell to open involves selling (writing) a new options contract to open a transaction. The investor may expect the options price to decline in the future and then hope to buy it back at a lower price to potentially secure a profit. Selling to open can also allow an investor to collect a premium by selling to another investor.
For a sell to open put, an investor may have a neutral to bullish view, and would be willing to take the assignment risk of the the option being exercised by the buyer should the stock drop below the strike price. In exchange, the investor receives a premium and if the put option expires worthless, the investor keeps it as a potential profit.
However, selling a naked, or unhedged, option can expose the seller to unlimited risk. For example, if the underlying market rises quickly, the seller of a short call position could experience rapid losses.
With sell to open, there are three possible outcomes: the option may expire, be exercised, or the investor (seller) may purchase it (buy to close) to close the trade.
Example of Selling to Open
An investor sells to open a $100 strike call option expiring in three months for $5. The underlying asset (a stock) shares are trading at $95 in the market. Here's three potential situations describing a buy-to-close of an initial sell-to-open call option trade.
For potential profit
Two months have passed and the underlying shares have fallen to $90. The call option contract has fallen to $2 per contract, from $5. An investor wants to realize these gains, so they buy to close the short options position at $2, taking a $3 profit or $300 for the trade ($3 X 100 shares = $300).
Breakeven
Two months have passed and the shares have increased to $100. The call option has stayed at $5 and investor decides to close the position at $5 to breakeven. The investor sold the call for $5 and closed the transaction for $5 ($5 - $5) = $0.
At a loss
After two months, the underlying stock increases from $95 to $105; the call option’s value rose to $7. An investor can buy to close the short call position for $7; this will result in a loss of $2 on the trade ($5 - $7) or -$200 (-$2 X 100).
When to Consider Sell to Open
A sell-to-open order is an options order type where an investor sells (or writes) a new options contract with the expectation that the option will decrease in value. This strategy can be employed for both call and put options. An investor can sell to open a call when they expect the value of the underlying asset to decrease (bearish sentiment) and for put options, an investor sells to open a put when they expect the value of the underlying asset to increase (bullish sentiment).
Potential Pros and Cons of Selling to Open
Employing selling to open option orders can be a strategic move in options trading, but it comes with advantages and disadvantages.
Pros
Time decay (theta) works to an investor's advantage as option sellers can keep the premium if the option expires worthless.
Can benefit from lower implied volatility
Receives premium upfront, providing the potential for an income stream
Cons
A naked call sale can potentially result in unlimited losses if assigned as the seller is obligated to purchase the stock at the market price if the stock price rises significantly and sell it at the strike price; this can be much higher than the strike price.
Rising volatility can be challenging for options sellers as it equates to greater unpredictability and risk.
Brokerage firms often impose higher margin requirements on sell-to-open positions due to the associated risks. This can limit the trader’s ability to potentially leverage their portfolio.
What is Sell to Close
Sell to close refers to selling an option to close a position that was initially purchased in order to open the transaction. This effectively allows the trader to exit their position on that option. The outcome of a sell-to-close transaction can vary. For a sell to close call it might result in a potential profit if the option's value has increased, but it could also lead to no gain or even a loss if the option's value has decreased compared to its purchase price.
Keep in mind the below example is for a sell to close for a call. Investors can also do a sell to close for puts. This can be done if the investor has a slightly bearish sentiment on the underlying stock and is interested in this strategy.
Example of Selling to Close
Let’s review three sell-to-close situations for a call transaction. A trader holds a $100 strike call option expiring in three months; they purchased the options contract for $5 when underlying shares traded at $95.
For a profit
Two months have passed and the underlying shares have increased to $110. The call option has increased to $12, up from $5 per contract. The trader wants to lock in the gains and decides to sell to close the long option position. They execute the order at $12, securing a $7 profit ($12 - $5 = $7) or $700 ($7 X 100).
Breakeven
Two months have again passed and the stock has increased to $100. The call option remained at $5 and the investor decides to close their position at $5 to breakeven. This means they bought the call at $5 and sell to close it at $5 for a $0 profit ($5 – $5).
At a Loss
The option may be losing value after two months and an investor decides it may be a good idea to implement a sell-to-close order. Let's assume the shares have increased to $96 from $95 and the call option’s value may have declined to $2.
To sell to close the long call position at $2, this can result in a $3 loss on the trade. If the investor bought the call at $5 and closed the transaction at $2, this results in a $3 loss or -$3 x 100 = -$300.
Potential Pros and Cons of Selling to Close
Selling to close has both pros and cons. Understanding these can be helpful when investors are trading options.
Pros
Avoids additional commissions vs. selling shares in the open market after exercising an ITM call option
Can potentially help limit losses by closing out options before they expire and decrease further in value.
Cons
Potential commission from the options sale
May incur an opportunity cost as there's potential to miss further gains in the underlying asset if it moves favorably after the sell
Market timing is important when attempting to maximize potential profits so investors need to keep an eye on the trades
Sell to Open vs Sell to Close: Understanding the Differences
While they sound very similiar, there is a difference between sell-to open and sell-to-close orders. A sell-to-open order is when an investors sell (or writes), a new options contract. This action creates an obligation for the seller, depending on whether it's a call or put option. A sell-to-close order is used to sell an existing options contract that an investor already holds. Both calls and puts can be subject to sell-to-open vs sell-to-close orders.
How to trade options using Moomoo
Moomoo provides a user-friendly options trading platform. Here's a step-by-step guide to get you started:
Step 1: Navigate to your Watchlist, then select a stock's "Detailed Quotes" page.
Images provided are not current and any securities are shown for illustrative purposes only and is not a recommendation.
Step 2: Navigate to Options> Chain located at the top of the page.
Step 3: By default, all options with a specific expiration date are shown. For selective viewing of calls or puts, simply tap "Call/Put."
Images provided are not current and any securities are shown for illustrative purposes only and is not a recommendation.
Step 4: Adjust the expiration date by choosing your preferred date from the menu.
Images provided are not current and any securities are shown for illustrative purposes only and is not a recommendation.
Step 5: Easily distinguish between options: white denotes out-of-the-money, and blue indicates in-the-money. Swipe horizontally to access additional option details.
Images provided are not current and any securities are shown for illustrative purposes only and is not a recommendation.
Step 6: Explore various trading strategies at the screen's bottom, offering flexibility for your investment approach.
Images provided are not current and any securities are shown for illustrative purposes only and is not a recommendation.
FAQs about Sell to Close vs Sell to Open
What is the difference between buy to open and sell to open?
Buy to open signifies that an investor is initiating a long position by purchasing an option, with an expectation of potentially profiting from an increase in the option's value. Sell to open entails selling an option to establish a short position. The investors receives a premium and anticipates that the option will depreciate or expire worthless.
How do you close a sell-to-open call?
An investor can close a short option position (sell-to-open) by buying-to-close prior to expiration. Keep in mind that options may expire worthless, so an investor also could do nothing, avoid possible commissions and realize a profit based on the premium received when selling the option. However, by leaving an option open, there's risk the option price could move unfavorably before expiration or possible assignment risk at expiration.
How can you potentially make a profit on a sell-to-open put?
In this strategy, here's a few ways it may be beneficial:
Earn premium income: Collect the option premium paid by the buyer. If the price of the underlying stock is above the strike price at expiration, the put option expires worthless, allowing you to keep the entire premium as profit.
Take advantage of time decay: Options usually decrease in value as they approach their expiration date (time decay). By selling put options, you can potentially benefit from this time decay as the option's value usually erodes over time.
