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.
Basics of Sell To Open
Sell to open refers to instances in which an option investor initiates, or opens, 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. Options are a type of derivative security.
Selling to open allows an investor to be eligible for a premium as the investor 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, or the purchase of a security with the hope that it will increase in value. The investor shorting the position is hoping the underlying asset or equity does not move beyond the strike price, as this allows her to keep the stocks and benefit from the long investor's premium.
Put and Call Options
Sell to open can be established on a put option or a call option or any combination of puts and calls depending on the trade bias, whether bullish, bearish or neutral, that the option trader or investor wants to implement. With a sell to open, the investor writes 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.
- Sell to open is the opening of a short position on an option by a trader. The opening enables the trader to receive cash or the premium for the options.
- The call or put position associated with the option may be covered, in which the option owner owns the underlying asset, or naked, which are riskier.
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 would be 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.
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 more risky than a covered call, as it involves establishing a short call position on a stock not held by the investor.
Example of Sell to Open
Suppose a trader XYZ thinks that stock ABC's price will go down in the coming weeks. Then XYZ opens a Sell to Open position on ABC's call options. This means that the trader is speculating on a downward move for ABC's price and selling its call options to the market maker, who has bet that ABC's price will go up. Opening the short position enables XYZ to collect premiums on ABC's call options.