If you’re familiar with stock trading including short selling you know there are multiple kinds of orders. If you are not familiar then you might only be familiar with buy and sell. Well with stocks there is buy, sell, sell short, and sometimes (though not always) buy to cover. Not even sure I’ve seen the last one. If it is not an order then it is a concept. I tend not to sell short. I use options to bet against a stock, but selling short makes me nervous.
In options trading there are 4 kinds of orders: buy to open, buy to close, sell to open, sell to close. The one you use differs based on what you are doing (buying or writing) and your goal (selling or closing). You need to understand the kinds of orders well. You do not want to mix them up and do the wrong thing. Let me go over some key option points before going into the orders.
Options are still subject to the pattern day trader rules. So those 4 round trips will nail you. The thing is, trading options and writing covered calls or cash-secured puts don’t require margin. Options are so fast moving you do not want to be hit by pattern daytrader. Now I know most of us hate the T+3 rule for cash accounts. Well options settle next day. So if I sell Monday, I have access to my cash Tuesday, always! So since I might want to do like 10 options in a day, and I nail all of them so I should bank my profits, I would just do so. Then I would be able to continue the next day. Its great. Now onto the orders.
You should read the previous article before jumping into this one.
Buy to Open
Buying to open is the option equivalent to going long on an option. In this case you are the option buyer. You are buying the right from the option writer. You are paying the premium. This is how you take that position. You can buy to open a call or a put. If its a call you have the right to have shares delivered to you. If you buy to open a put you can force someone else to buy. When you do this you choose your strike, expiry, and premium. Most importantly you choose your quantity. Remember a premium of 0.10 means $10 an option. Everything is x100. So if it is a $1 premium that is $100.
Sell to Close
This is like the sale of a stock. You are closing your long position. This is what options traders would do. People using options for hedging or protection would wait for expiry and/or exercise (exercising will be a different article). Hopefully, the premiums have gone up, and you make a profit. Sometimes even hedgers will close to salvage some premium, but this is rarer in my opinion.
Sell to Open
This is how you write options. You write calls and write puts. You sell to open, which is like going short. You receive the premium, and sold your right to control your actions in a narrow circumstance. Just remember what I said in the last article you might see a really high negative number and have a mini-heart attack. It is not a real account drain. It is the cost of closing the position. You keep the premium. This effect is really noticeable when you have covered calls, where the underlying shares are very green. It just keeps rising past your strike price and your option shows a scary red number. However, you’re profitable, you keep the premium. The negative position is like your missed opportunity. It is what you could have made. The thing is the strategy cuts your gains, but it offers cash now, and can be recurring if the price stays below your strike, or above it if its a put.
Buy to Close
When you write options contracts sometimes you want to close them for whatever reason. Maybe you see a new piece of news and you know that its going to double now. Your covered call is going to rob you of some serious gains. Maybe you want to close an expiring contract that is like $0.01 so that you can pick an expiry further away and bring in some cash. You can’t do this without freeing up your shares. The point is something when you write a contract you want to be finished. So you buy to close. Remember writing is like going short. It appears as a negative quantity. To close out the position you need to buy back the contracts you put out into the world. They will disappear if it expires, but you might have your reasons. That is what buying to close is.