Buy To Open VS Buy To Close : There are only four basic techniques to trade in the options market, despite the numerous exotic-sounding variations.
You have the choice to buy or sell call options or put options. You’re betting on the price direction of the underlying asset, regardless of which side of the trade you’re on.
However, the buyer and seller of options have completely different goals in mind.
Important Points:
• Purchasing a call option, selling a call option, buying a put option, and selling a put option are the four basic options trades.
• The buyer of call options bets that the market price of an underlying asset will exceed a fixed price, known as the strike price, while the seller bets that it will not.
• The option buyer bets that the market price of the underlying asset will go below the strike price, while the seller bets that it will not.
Buying and Selling Call Options
A call option gives the buyer, or holder, the right to buy the underlying asset at a fixed price before the option expires, such as a stock, currency, or commodity futures contract.
The holder of an option, as the name implies, has the right but not the duty to purchase the asset at the agreed-upon price (called the striking price).
Every option is, in essence, a contract between two parties, or a bet.
The buyer of call options is betting that the open market price of the underlying asset will be higher than the strike price—and that it will exceed the strike price before the option expires.
If this is the case, the option buyer can purchase the asset at the strike price from the option seller and then resell it for a profit.
A call option buyer must pay an upfront price for the right to make the transaction. The cost, known as a premium, is given up front to the seller, who is betting that the asset’s market price will not be greater than the option price.
That premium is the profit the seller wants in most simple options. It is also the option buyer’s risk exposure, or maximum loss. The premium is calculated as a proportion of the potential deal size.
Investing in Put Options
A put option, on the other hand, grants the buyer the right to sell an underlying asset at a predetermined price on or before a given date.
In this situation, the put option buyer is effectively shorting the underlying asset, betting that its market price will fall below the option’s strike price.
If this is the case, they can purchase the asset at a lower market price and then sell it to the option seller, who is compelled to purchase it at the higher, agreed-upon strike price.
Again, the put seller, or writer, is on the other side of the trade, betting that the market price will not go below the option’s price.
The put seller receives a premium from the option buyer for making this bet.
Some Terms Used in Option Trading
When doing these four fundamental trades, there are a few terminology to be aware of. A trader who “buys to open” a put or call option is referred to as “buying to open,” whereas a trader who “sells to open” is referred to as “writing to open.”
When the option holder, the original buyer of the option, closes out either a call or a put, this is known as “sell to close.”
When an option writer says “buy to close,” it signifies the put or call option they sold is being closed out.
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