What is 'Sell To Open'
Sell to open is a phrase used by many brokerages to represent the opening of a short position in an option transaction. Sell to open means the option investor is initiating, or opening, an option trade by selling or establishing a short position in an option. This enables the option seller to receive the premium paid by the buyer on the opposite side of the transaction.
BREAKING DOWN 'Sell To Open'Selling to open allows an investor to be eligible for a premium as he is selling the opportunity associated with the option to another investor within the market. This puts the selling investor in the short position on the call or put, while the second investor takes the long position. The investor shorting the position is hoping the underlying asset or equity does not move beyond the strike price as this can allow him to keep the stocks and benefit from the long investor's premium.
Put Option/Call Option
Sell to open can be established on a put option or call option or any combination of puts and calls depending on the trade bias, whether it is bullish, bearish or neutral, that the option trader or investor wants to implement. With a sell to open, the investor is writing a call or put in hopes of collecting a premium. The call or put may be covered or naked depending on whether the investor writing the call is currently in possession of the securities in question.
An example of a sell to open transaction is a put option sold or written on a stock, such as one offered through Microsoft. In this case, the put seller may have a neutral to bullish view on Microsoft, and is willing to take the risk of the stock being assigned, or put, if it drops below the strike price in exchange for receiving the premium paid by the option buyer.
Covered Calls and Naked Calls
As another example, a sell to open transaction can involve a covered call or naked call. In a covered call transaction, the short position in the call is established on a stock held by the investor. It is generally used to generate premium income from a stock or portfolio. A naked call, also referred to as an uncovered call, is riskier than a covered call, as it involves establishing a short call position on a stock not held by the investor. As such, it is similar to an outright short position in the underlying stock, with all the attendant risks involved in short selling.