What is Sell to Close?

Sell to close is an options trading order that is used to exit a trade in which the trader already owns the options contract and must sell the contract to close the position. Traders "sell to close" call options contracts they own when they no longer want to hold a long bullish position on the underlying asset. They "sell to close" put options contracts they own when they no longer want to hold a long bearish position on the underlying asset.

Understanding Sell to Close

Sell to close is simply the action of closing out the position by selling the contract. In options trading, both short and long positions are taken through contracts which are purchased. Once a contract is owned by a trader, it can only be dealt with three ways. One, the option is out of the money and expires worthless. Two, the option is in the money and can be exercised to trade for the underlying or settle for the difference. Three, the option can be sold to close the position. A sell to close order may be made with the option in the money, out of the money or even at the money.

Key Takeaways

  • Sell to close simply means to close out an options position by putting in an order to sell the contract.
  • A trader can sell to close for a profit, a loss or break even.
  • If an option is out of the money and will expire worthless, a trader may still choose to sell to close to clear the position.

Example of Selling to Close

Let's assume a trader is long an exchange-traded option using a buy to open order on a call option on Company A. Imagine that, at the time, the stock was priced at $175.00. Let's also assume that the $170.00 strike call, with an expiration date 90 days away, was selling for $7.50 per share. This gives the option $5.00 of intrinsic value ($175.00 stock price – $170.00 strike price = $5.00 intrinsic value) and $2.50 of extrinsic value ($7.50 option premium – $5.00 intrinsic value = $2.50 extrinsic value).

As time goes by and the value of Company A fluctuates up and down, the value of the call option is going to fluctuate as well. The higher the value of the call option goes, the more profitable it will become. Conversely, the lower the value of the call option goes, the less profitable it will become. However, those profits, or losses, will only be realized once the trader exits the position using a sell to close order. There are three possible outcomes when a trader sells to close a long option.

Outcome #1: Sell to Close for a Profit

If the price of the underlying asset increases more than enough to offset the time decay the option will experience (the closer it gets to expiration) then the value of the call option will also increase. In this case, a trader can sell to close the long call option for a profit. 

Let's assume in this scenario that Company A rises from $175.00 to $180.00 by expiration, increasing the value of the call option from $7.50 to $10.00. This option is now comprised of $10.00 of intrinsic value ($180.00 stock price – $170.00 strike price = $10.00 intrinsic value) and $0.00 of extrinsic value (options have no extrinsic value at expiration). The trader can now sell to close the long call option position for a profit of $2.50 ($10.00 current value – $7.50 purchase price = $2.50 profit).

Outcome #2: Sell to Close at Break Even

If the price of the underlying asset increases only enough to offset the time decay the option will experience then the value of the call option will remain unchanged. In this case, a trader can sell to close the long call option at break even. 

Let's assume in this scenario that Company A rises from $175.00 to $177.50 by expiration, keeping the value of the call option at $7.50. This value is comprised of $7.50 of intrinsic value ($177.50 stock price – $170.00 strike price = $7.50 intrinsic value) and $0.00 of extrinsic value. The trader can now sell to close the long call option position at break even ($7.50 current value – $7.50 purchase price = $0.00 profit).

Outcome #3: Sell to Close for a Loss

If the price of the underlying asset does not increase enough to offset the time decay the option will experience, then the value of the call option will decline. In this case, a trader can sell to close the long call option at a loss. 

Let's assume in this scenario that Company A only rises from $175.00 to $176.00 by expiration, dropping the value of the call option to $6.00. This value is comprised of $6.00 of intrinsic value ($176.00 stock price – $170.00 strike price = $6.00 intrinsic value) and $0.00 of extrinsic value. The trader can now only sell to close the long call option position at a loss of $1.50 ($6.00 current value – $7.50 purchase price = $1.50 loss).