What is Buy To Open?
"Buy to open" is a term used by brokerages to represent the establishment of a new (opening) long call or put position in options. A buy to open order indicates to market participants that the trader is establishing a new position rather than closing out an existing position. The "sell to close" order is used to exit a position taken with a buy to open order. Establishing a new short position would be labeled "sell to open," which would be closed out with a "buy to close" order.
Basics of Buy To Open
The buy and sell terminology for options trading is not as straightforward as it is for stock trading. Instead of simply placing a "buy" or "sell" order as they would for stocks, options traders must choose among "buy to open," "buy to close," "sell to open" and "sell to close."
A buy to open position may indicate to market participants that the trader initiating the order believes something about the market or has a particular axe to grind. This is particularly true if the order is large. However, this does not have to be the case, since options traders frequently engage in spreading or hedging activities where a buy to open may actually offset existing positions.
During certain market conditions - for instance, if a stock with options on it is to be delisted or is halted for an extended period of time - the exchange may declare that only closing orders be initiated, and so a buy to open order would be denied.
Buy to Close in Stocks
Buy to open applies to stocks as well. When an investor decides to establish a new position in a particular stock, the first buy transaction is considered buy to open because it opens the position. By opening the position, the stock is being established as a holding in the portfolio. The position remains open until it is closed out by selling all the stocks. This is known as selling to close because it closes the position. Selling a partial position means that some, but not all, stocks have been sold. A position is considered closed when no more of a particular stock, or exposure to it, remains in a portfolio.
Buy to close orders also come into play when covering a short-sell position. A short-sell position borrows the shares through the broker and is closed out by buying back the shares in the open market. The last transaction to completely close out the position is known as the buy to close order. This removes the exposure completely. The intent is to buy back the shares at a lower price to generate a profit from the difference of the short-sell price and the buy to close price.
In some cases, where the share price moves higher, the trader may have to buy to close at a loss to prevent even greater losses from occurring. In the worst-case scenarios, the broker may execute a forced liquidation as a result of a margin call - a broker's demand that an investor place money in his margin account owing to a shortfall - which would generate a buy to cover order to close out the position at a magnified loss due to insufficient account equity.
- The Buy to Open position is generally used by traders to open positions in a given option or stock. A Sell to Close position is generally used to close out the position.
- A Buy to Close position occurs during short-selling when a trader buys up the stock that she shorted in the open market. In some cases, where the share price moves higher, the trader may have to buy to close at a loss to prevent bigger losses.
Example of Buy to Open
Suppose a trader has done her analysis and believes that the price of XYZ stock will go up in the near future. She purchases call options for the stock by placing a Buy to Open order.