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While I think I understand the mechanics of opening a call position, I am confused about the mechanics of closing a call option prior to expiry. I am party A.

Buy-to-open:

  • Party A (buy-side) is bullish on a stock and places a buy-to-open order for a call option
  • Party B (sell-side) is bearish on that stock and sells-to-open that call to party A
  • Party A now has the right (not the obligation) to buy the stock on strike date/price from party B
  • Party B has the obligation to sell the stock on strike date/price to party A

If party A's call is in-the-money prior to the strike date, the call's intrinsic value increased. Let's assume party A wants to take profits now.

Sell-to-close:

  • Party A wants to take those profits and places a sell-to-close order for the call
  • The order is filled
  • After party A sells-to-close, party A does not have any right/obligation to buy/sell the underlying

Questions:

Who is party B on the buy-side of A's sell-to-close trade?

If party A doesn't have the obligation to sell anything to party B following B's purchase of A's in-the-money call option, why does party B buy the call?

3

By selling-to-close the original buy-to-open position with the exact same contract, you are creating offsetting positions. Imagine there is only one options contract in the universe. You bought it from person A whom sold it to you (let's assume they sold to open) and you sell it to person C. You no longer have any obligations wrt to this contract but person A still does.

In reality, if I'm not mistaken these transactions generally are cleared though a clearing house and chains of closed positions are more than likely novated (i.e. change parties to a contract) to remove parties with closed positions in order to break chains of closed positions.

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  • so, in simple terms, you're saying that the call is bought by someone else that is also bullish in the underlying but that believes the call will go deeper into the money, correct? can you elaborate on "chains of closed positions" and "remove parties" remove from where? – sudonym May 8 at 2:01
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    @sudonym They might be buying it because they think it will increase in value, but they could just be buying to close out their position. – Hart CO May 8 at 2:20
  • @HartCO so in the first case they would buy to open, and in the latter case buy to close - got it – sudonym May 8 at 2:23
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    @sudonym Right, it has value, the person who sold it might lose less money if they buy it back, or someone else could be closing out their position at a gain by buying it. – Hart CO May 8 at 2:29
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    @sudonym - The second call buyer could be (1) buying the call because he believes that the stock is going higher, (2) Buying the call to close a short call position, or (3) Buying the call (to open) to hedge a short stock position. – Bob Baerker May 8 at 3:09
1

(A) buys a call to open from counter party (B) who sells the call to open. There are four possible outcomes:

  1. The contract is OTM at expiration and expires worthless

  2. (A) exercises the ITM call to buy the stock from (B)

  3. (A) sells his call to (C) and the counter parties are now (B) who is short the call and (C) who is long

  4. No one does anything and the call expires in-the-money (ITM). Since the Option Clearing Corp exercises all options that expire ITM, (A)'s long call is exercised and (B)'s short call is assigned. This has the same effect as #2.

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  • Have you left out the case where the option expires out of the money (by more than one cent)? – Tanner Swett May 8 at 3:59
  • @BobBaerker thanks for clarification. my initial misunderstanding was that when A sells to C, the initial obligation from B will migrate from B to A because 'the seller has the obligation to buy the underlying' and A is the seller now and not B anymore. This is equivalent to sell-to-open an option after buy-to-open it (which I think is not possible) – sudonym May 8 at 5:08
  • I just wasn't sure whether it was on purpose or accidental that you didn't mention the case of expiring OTM. – Tanner Swett May 8 at 12:03
  • @Tanner Swett - It was an out to lunch moment :-). Thanks for catching that. – Bob Baerker May 8 at 12:37

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