1

I was recently on Optional Alpha, which provides an overview of how to trade options, from A to Z.

During one of the videos/lectures, there was an introduction for: buy to open, sell to close, sell to open and buy to close.

The latter was true for option sellers. As I understood from the videos, an option seller can get out of the contract, by buying the same contract, and in some cases profit, if the price of that contract is lower.

However, doesn't the seller's obligation to fulfill the put/call option still remain? What if the strike price will move in a very favorable position? Would they still be able to effectively get out of their "sell to open trade" by taking the opposite e.g buy to close?

The above notion was introduced under the concept of debit and credits.

I believe that I have this concept a bit mixed up. I would be grateful if someone could provide some clarity.

4

However, doesn't the sellers obligation to fullfill the put/call option still remain?

No. Buying to close effectively transfers the obligation to buy or sell the underlying stock to the party that sells you the option, so you are, for all intents and proposes, out of the contract. The clearing house cancels out your position and you have no exposure whatsoever. Your profit or loss is determined by whether you bought the option for less or more that you received for the option sold to open the position.

Suppose the clearing house did NOT cancel your position, and you were short one option and long another. If the option you sold (a call for this example) is in the money, is exercised, and you have to sell the stock, then the option you bought to close will be in the money, you would choose to exercise it and buy the stock at the same price from someone else, so you are effectively netted out of any position.

What if the strike price will move in a very favorable position? Would they still be able to effectively get out of their "sell to open trade" by taking the opposite e.g buy to close?

Sure - it would just cost more to buy the closing option, reducing your gain. (Note technically that the strike of an option doesn't move, but I'm assuming you mean the stock price)

  • "you'll buy the stock" - did you mean option? Because prior you wrote "then the option you bought to close will be in the money". Hopefully, he just closes out the option position, doesn't need to deliver stock. – JTP - Apologise to Monica Feb 4 '18 at 21:22
  • @JoeTaxpayer no, I mean if you buy a call to close your position, then you'd exercise the call, buying the stock. Of course, the clearing house takes care of all of this for you, but I was illustrating why buying to close cancels out your position. – D Stanley Feb 4 '18 at 21:39
  • Hmmmm. When I am short a call, and buy to close, that's it, the buying is what gets me out. I no longer have the risk of being assigned. The guy that sold me the call is now on the hook. If I don't buy to close, I will need to deliver the stock if I wait until expiration for a call that's in the money. – JTP - Apologise to Monica Feb 4 '18 at 22:20
  • @JoeTaxpayer OK, I see what you're saying. I didn't make it clear enough that the example was a hypothetical to show that the buy to close actually cancels the position. I've updated the answer. – D Stanley Feb 4 '18 at 22:29
  • @DStanley: Yes, BTC the option transfers the obligation to the seller. You are out of the contract. PERIOD.Your explanation involving the stock is incorrect. If you sold a covered call then either (1) the call ends up OTM and expires, (2) you are assigned (you must sell the stock at the strike price), or )3) you buy to close the contract. If you BTC the call it removes the short call from your account. You can't exercise a contract that you don't own in order to buy the stock. You are simply left with your long shares. – Bob Baerker Feb 4 '18 at 22:29
1

Opening option positions are BTO and STO. They are closed out by STC and BTC, respectively.

Everyone gets out of their open contract by effecting a closing transaction. When you BTC your short option, the contractual obligation shifts to the counter party that you bought the contract from and there is no further obligation on your part whatsoever. The P&L is determined by Net Sale Price minus Net Buy Cost.

The contract can also be terminated by exercise by the option owner which results in assignment to an option writer.

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.