What does Buy To Close mean?
Buy to close is the purchase of an option position. A trader will buy an asset to offset, or close, a short position in that same asset. Essentially, it is the buying back of an asset initially sold short. The net result is no exposure to the asset.
BREAKING DOWN Buy To Close
There is a nuanced difference between a buy to close option and a buy to cover purchase. The former refers to futures and options, while the latter typically refers to stocks only. The net result is the same, however.
In the case of stocks, selling assets short involves borrowing the asset from another entity. For futures and options, the process involves writing a contract to sell it to another buyer. In both cases, the trader hopes the price of the underlying stock moves lower to generate a profit at the trade's closing.
For stocks, and barring bankruptcy in the underlying company, the only way to exit the trade is to buy shares back and return them to the entity from whom they were borrowed. In a futures transaction, the trade ends at maturity or when the seller buys back the position in the open market to cover their short position. For an options position, the trade ends at maturity, when the seller buys back the position in the open market, or when the buyer of the option exercises it.
In all cases, if the purchase or cover price is less than the selling or shorting price, there is a profit for the seller.
Buy to Close and Shorting Against the Box Positions
It is possible to carry a short position in an asset and a long position in the same asset at the same time. This strategy is called shorting against the box. There are many reasons why traders would do this, but the primary purpose is to maintain the history of the long position. For example, a stock held in an account for many years might have a sizable unrealized profit. Instead of selling it to take advantage of short-term market conditions and trigger a tax liability, the trader can borrow other shares to sell short.
Not all brokers allow this type of transaction. Additionally, changes in taxation rules trigger the liability at the time of the short sale. Therefore, while it is possible to do, this sort of transaction is no longer desirable or practical.
The same applies to holding a short position and then attempting to purchase a long position. Most brokers will merely offset the two positions, essentially creating a buy to close situation.