Editor's Note: Options are not suitable for all investors. Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Please see the Characteristics and Risks of Standardized Options.
Table of Contents
Sell-to-open and sell-to-close are two of the four order types used in options trading. The other two are buy-to-open and buy-to-close. Options contracts can be created, closed out, or exchanged on the open market.
A sell-to-open order is an options order type in which you sell (or write) a new options contract.
In contrast, a sell-to-close order is an options order type in which you sell an options contract you already own. Both call and put options are subject to these order types.
Key Points
• Sell-to-open involves selling (or writing) a new options contract, while sell-to-close involves selling an existing options contract.
• A trader may sell-to-open a call option when they believe the price of the underlying asset will decrease, or sell-to-open a put option when they believe the price will increase.
• Sell-to-open can increase open interest when paired with a buyer opening a position, while sell-to-close can reduce or leave open interest unchanged depending on the counterparty’s order type.
• Sell-to-open benefits from time decay and lower implied volatility, but may result in steep losses and be affected by increasing volatility.
• Sell-to-close helps to avoid extra commissions and slippage costs and may retain extrinsic value, but limits further upside before expiration.
What Is Sell-to-Open?
A sell-to-open transaction is performed when you want to short an options contract, either a call or put option. The trade is also known as writing an option contract.
In options trading, selling a put typically indicates a neutral-to-bullish sentiment on the underlying asset, while selling a call indicates bearish or neutral sentiment depending on strategy, such as a covered call.
When writing options, you collect the premium upon the sale of the option. You may benefit if you are correct in your assessment of the underlying asset price movement. You may also benefit from sideways price action in the underlying security — essentially theta, or time decay — but this is only one factor that may influence option prices and could be outweighed by volatility or price changes.
A sell-to-open order creates a new options contract. Writing a new options contract will increase open interest if the contract stays open through the close of that trading session, all other things being equal.
How Does Sell-to-Open Work?
A sell-to-open order initiates a short options position. If you sell-to-open, you could be bullish or bearish on an underlying security depending on whether you are short puts or calls.
Writing an option gives the buyer the right, but not the obligation, to buy or sell the underlying asset from you at a pre-specified price. If the buyer exercises that right, you, the seller, are obligated to sell them the security at the strike price.
An options seller may benefit when the price of the option drops, though implied volatility shifts, liquidity, and underlying price movement can affect real-life outcomes. The seller may secure profits by buying back the options at a lower price before expiration, but this depends on option liquidity and bid-ask spreads. The seller also benefits if the option expires worthless since they keep the premium without having to fulfill the contract’s obligations.
Selling-to-open an option on an underlying security that isn’t owned by the seller — referred to as a naked option — is considered extremely high risk, since the seller could face substantial (or theoretically unlimited) losses upon assignment.
Pros and Cons of Selling-to-Open
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Pros:
• Collects an upfront premium that compensates the seller for taking on obligation and assignment risk
• Time decay may work in your favor when underlying price and volatility remain stable
• May benefit from decreasing implied volatility, though the effect depends on overall market conditions
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Cons:
• Faces the risk of assignment if the underlying asset price moves adversely, which could result in losses
• A naked sale entails significant margin requirements and could result in substantial or (theoretically) unlimited losses if assigned
• Increasing volatility can significantly raise the option’s value and widen bid-ask spreads, increasing the cost to exit a short position
An Example of Selling-to-Open With 3 Outcomes
Let’s explore three hypothetical outcomes after selling-to-open a $100 strike call option expiring in three months on XYZ stock, trading at $95. You collect $5 in premium per share, or $500 total since an options contract typically controls 100 shares.
1. For a Profit
After two months, XYZ shares dropped to $90. The call option contract you sold fell from $5 per share to $2. You decide that you want to book these gains, so you buy-to-close your short options position.
The purchase executes at $2. You have secured your $3 profit, or $300 total across the 100 shares (not accounting for any fees or commissions paid).
You sold the call for $5 and closed out the transaction for $2: $5 – $2 = $3 in profit.
A buy-to-close order is similar to covering a short position on a stock.
Keep in mind that the price of an option consists of both intrinsic and extrinsic value. Because the stock price ($90) is below the strike price ($100), the option has zero intrinsic value. The remaining $2 price consists entirely of extrinsic value, meaning the portion of an option’s value that exceeds its intrinsic value.
Options pricing can be complex, as there are many variables in pricing models, such as the Black-Scholes or binomial model.
2. At Breakeven
If, however, XYZ shares increase modestly in the two months after the short call trade was opened, then time decay (or theta) might simply offset the rise in intrinsic value.
Let’s assume the shares rose to $100 during that time. The call option remains at $5 due to the offsetting changes in intrinsic value and time value.
You decide to close the position for $5 to breakeven.
You sold the call for $5 and closed out the transaction for $5: $5 – $5 = $0 in profit.
3. At a Loss
If the underlying stock climbs from $95 to $105 after two months, let’s assume the call option’s value jumped to $7. The decline in time value is less than the increase in intrinsic value.
You choose to buy-to-close your short call position for $7, resulting in a loss of $2 on the trade, or $200 across the 100 shares.
You sold the call for $5 and closed out the transaction for $7: $7 – $5 = $2 loss.
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What Is Sell-to-Close?
A sell-to-close is executed when you close out an existing long options position.
When you sell-to-close, you sell the contract you were holding to another party, which may result in a profit or loss.
Open interest can stay the same or decrease after a sell-to-close order is completed, depending on whether the buyer is opening or closing a position.
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How Does Sell-to-Close Work?
A sell-to-close order ends a long options position that was established with a buy-to-open order.
When you sell-to-close, you might have been bullish or bearish on an underlying security depending on if you were long calls or puts. (These decisions can be part of options trading strategies.) A long options position has three possible outcomes:
1. It expires worthless
2. It is exercised
3. It is sold before the expiration date
Pros and Cons of Selling-to-Close
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Pros:
• Avoids extra commissions versus selling shares in the open market after exercising
• Avoids possible slippage costs
• Retains extrinsic value if the option is sold before expiration and is not deep in-the-money
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Cons:
• There might be a commission with the options sale
• The option’s liquidity could be poor
• Limits further upside before expiration
An Example of Selling-to-Close With 3 Outcomes
Let’s dive into three plausible scenarios whereby you would sell-to-close.
Assume that you are holding a $100 strike call option expiring in three months on XYZ stock that you purchased for a premium of $5 ($500 total for the contract’s 100 shares) when the underlying shares were $95.
1. For a Profit
After two months, XYZ shares rally to $110. Your call options jumped from $5 per share to $12.
You decide that you want to book those gains, so you sell-to-close your long options position.
The sale executes at $12. You have secured your $7 profit, or $700 total across the 100 shares (not accounting for any fees or commissions paid).
You purchased the call for $5 and closed out the transaction for $12: $12 – $5 = $7 in profit.
2. At Breakeven
Sometimes a trading strategy does not pan out, and you just want to sell at breakeven. If XYZ shares rally only modestly in the two months after the long call trade was opened, then time decay (or theta) might simply offset the rise in intrinsic value.
Let’s say the stock inched up to $100 in that time. The call option remains at $5 due to the offsetting changes in intrinsic value and time value.
You decide to close the position for $5 to breakeven.
You purchased the call for $5 and closed out the transaction for $5: $5 – $5 = $0 in profit.
3. At a Loss
If the stock price does not rise enough, cutting your losses on your long call position can be a prudent move. If XYZ shares climb from $95 to $96 after two months, let’s assume the call option’s value declines to $2. The decline in time value is more than the increase in intrinsic value.
You choose to sell-to-close your long call position for $2, resulting in a loss of $3 on the trade, or $300 across the 100 shares.
You purchased the call for $5 and closed out the transaction for $2: $5 – $2 = $3 loss.
What Is Buying-to-Close and Buying-to-Open?
Buying-to-close ends a short options position, which could be bearish or bullish depending on whether calls or puts were used.
Buying-to-open, in contrast, establishes a long put or call options position which might later be sold-to-close.This is the reverse of sell-to-open, where a position is initiated by writing the contract.
Understanding buy to open vs. buy to close is similar to the logic with sell-to-open vs. sell-to-close.
Test your understanding of what you just read.
The Takeaway
Selling-to-open initiates a short options position by creating a new contract obligation, while selling-to-close exits a previously established long position. The former is executed when writing an options contract, while the latter closes a long position. It is important to know the difference between sell-to-open vs sell-to-close before you start options trading.
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FAQ
Is it better to buy options at opening or closing?
It is hard to determine what time of the trading day is best to buy and sell stocks or options, and it may depend on your goals. In general, however, the first hour and last hour of the trading day are the busiest, so there may be more opportunities during those periods with better market depth and liquidity. However, higher volatility can also mean increased risk. The middle of the trading day sometimes features calmer price action, but big news could turn the tables at any time.
Can you always sell-to-close options?
If you bought-to-open an option, you can sell-to-close so long as there is a willing buyer. However, low liquidity or wide bid-ask spreads may make closing a position difficult or less favorable. You might also consider allowing the option to expire if it will finish out of the money. A final possibility is to exercise the right to buy or sell the underlying shares.
How do you close a sell-to-open call?
You close a sell-to-open call option by buying-to-close before expiration. Bear in mind that the options might expire worthless, so you could do nothing and avoid possible commissions. If the option is in the money at expiration, assignment may occur and you would be required to fulfill the contract.
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Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
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