4 Ways to Trade Options: Buy to Open, Sell to Open, Buy to Close, Sell to Close

While there are various exotic-sounding variations, there are ultimately only 4 basic positions to trade in the choices market: You may either buy or sell call options, or buy or sell put options. In establishing a brand new position, options traders can either buy or sell to open. Existing positions are canceled by either selling or buying to shut.

No matter which side of the trade you are taking, you make a bet on the worth direction of the underlying asset. But the customer and seller of options stand to profit in very other ways.

Key Takeaways

  • There are 4 basic options positions: buying a call option, selling a call option, buying a put option, and selling a put option.
  • With call options, the customer is betting that the market price of an underlying asset will exceed a predetermined price, called the strike price, while the vendor is betting it won’t.
  • With put options, the choice buyer is betting the market price of an underlying asset will fall below the strike price, while the vendor is betting it won’t.
  • Buyers of call or put options are limited of their losses to the fee of the choice (it’s premium). Unhedged sellers of options face theoretically unlimited losses.
  • Spreads with options involve concurrently buying and selling different options contracts on the identical underlying.

What Do The Phrases “Sell To Open,” “Buy To Close,” “Buy To Open,” And “Sell To Close” Mean?

Trading Call Options

A call option gives the customer, or holder, the correct to purchase the underlying asset—equivalent to a stock, currency, or commodity futures contract—at a predetermined price before the choice expires. Because the name “option” implies, the holder has the correct to purchase the asset on the agreed price—called the strike price—but not the duty.

Every option is basically a contract, or bet, between two parties. Within the case of call options, the customer is betting that the worth of the underlying asset will likely be higher on the open market than the strike price—and that it is going to exceed the strike price before the choice expires. In that case, the choice buyer should buy that asset from the choice seller on the strike price after which resell it for a profit.

The client of a call option must pay an upfront fee for the correct to make that deal. The fee, called a premium, is paid on the outset to the vendor, who’s betting the asset’s market price won’t be higher than the worth laid out in the choice. In most simple options, that premium is the profit the vendor seeks. It is usually the danger exposure, or maximum loss, of the choice buyer. The premium is predicated on a percentage of the scale of the possible trade.

Trading Put Options

A put option, however, gives the customer the correct to sell an underlying asset at a specified price on or before a certain date. On this case, the customer of the put option is basically shorting the underlying asset, betting that its market price will fall below the strike price in the choice. In that case, they should buy the asset on the lower market price after which sell it to the choice seller, who’s obligated to purchase it at the upper, agreed strike price.

Again, the put seller, or author, is taking the opposite side of the trade, betting the market price won’t fall below the worth laid out in the choice. For making this bet, the put seller receives a premium from the choice buyer.

Call and put options have a risk metric generally known as the delta. The delta tells you ways much the choice’s price will are inclined to change given a $1 move within the underlying security.

To Open vs. to Close

There are additional terms to know when executing these 4 basic trades. The phrase “buy to open” refers to a trader buying either a put or call option that establishes a brand new position. Buying to open increases the open interest in a selected option, and increasing open interest can signal greater liquidity and point to market expectations. “Sell to shut” is when the holder of the choices (i.e., the unique buyer of the choice) closes out their call or put position by selling it for either a net profit or loss. Note that options positions will at all times expire on the expiration date for a selected contract. At that time, in-the-money options will likely be exercised and out-of-the-money options will expire worthless. There isn’t any must sell to shut if an options position is held to expiration.

A trader may “sell to open,” establishing a brand new position that is brief either a call or a put. A brief put is definitely taking a protracted position within the underlying market because put options rise in value because the underlying price declines. If you sell an option “naked” (i.e., unhedged), the choice seller (known sometimes as the author) is exposed, in theory, to unlimited risk. It is because the vendor of an option receives the premium on the time of the trade, but when a brief call position sees a rapidly rising underlying market, they’ll quickly see losses mount. “Buy to shut” means the choice author is closing out the put or call option they sold.

Other Options Terminology

Along with these 4 basic options positions, traders may use options to construct spreads or mixtures. A diffusion involves buying and selling options together on the identical underlying, while a mix is buying (selling) two or more options. Listed here are a number of basics:

  • Vertical call/put spread: Buy (sell) one call (put) and sell (buy) and more out-of-the-money call (put). Vertical spreads that profit in up markets are bull spreads; in down markets bear spreads.
  • Calendar Spread: Buy (sell) an option with one maturity to sell (buy) an option with a special maturity.
  • Straddle: buying each a call and a put of the identical strike and expiration
  • Strangle: buying each a call and a put at the identical expiration but different (out-of-the-money) strikes.
  • Butterfly: a market-neutral strategy involving buying (selling) a straddle and selling (buying) a strangle
  • Covered Call: sell shares against an existing stock position.
  • Protective Put: buy shares against an existing stock position.

Is Trading Options Good for Beginners?

Options are more complex than basic stocks trading and require margin accounts. Due to this fact, basic options strategies could also be appropriate for certain beginners but only in any case risks are understood in addition to how options work. Basically, options used to hedge existing positions or for taking long positions in puts or calls are probably the most appropriate for less-experienced traders.

What Is the Difference Between a Call Option and a Put Option?

A call option gives the holder the correct (but not the duty) to purchase the underlying asset at a specified price at or before its expiration. A put contract as an alternative grants the correct to sell it.

Can I Lose Money Buying a Call?

In the event you buy a call, the breakeven price will likely be the strike price of the decision plus the premium (i.e., the worth) paid for it. So, if a $25-strike call is trading at $2.00 when the share price is at $20, the stock would must rise above $27.00 before it expires to interrupt even. If not, the trader will lose as much as a maximum of the $2.00 paid for the contract.

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