What Does Sell To Open Mean?
Sell to open is a brokerage instruction to open a short position in an options transaction.
When trading options (calls or puts) there really are only two choices when placing an order. Traders can either open a position or close a position. If traders sell to open a position, they are basically selling short or ‘writing’ an option to open the trade. To sell an option to establish a position the trader either needs the corresponding stock shares or their cash equivalent as collateral for the position. If a trader does not have the stock to back up the order, they are shorting the option. This is also known as selling a naked position. If the trader actually owns the shares to back up the trade, they are selling a covered position.
Basics of Sell To Open
Sell to open occurs when an options investor initiates or opens, an options trade. However, instead of buying, they open the 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 receive a premium. This is because the investor is selling the opportunity associated with the option to another investor. However, selling first puts the selling investor in the short position on the call or put. The second investor takes a long position or the purchase of a security. To profit, the long investor hopes that it will increase in value. The investor shorting the position hopes the underlying asset or equity does not move beyond the strike price.
How Options Work
One options contract controls a fixed amount of the underlying security. For example, an options contract can control 100 shares of Apple stock. Investors can trade two types of options – calls or puts.
- Call options – A call gives the right to buy the underlying security,
- Put options – A put gives the right to sell.
However, unlike stocks, options have a shelf-life. An option’s value decreases the closer it gets to the expiration date. The risk depends on whether the investor is buying the option or selling it. When a trader buys a call or put option, they limit the risk to the option’s purchase price and broker fees. The seller potentially bears the risk for the entire value of the underlying assets.
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 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 100 shares of stock. For example, such as one offered through Microsoft. In this case, the put seller may have a neutral to bullish view on Microsoft. Therefore, the seller 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.
Another example 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 typically used to generate premium income from a stock currently held in a portfolio. A naked call also referred to as an uncovered call, is riskier than a covered call. It involves establishing a short call position on a stock not held by the investor.
Possible Options Trades
Traders can either buy or sell call options or buy or sell put options. Regardless of which side of the trade they take, they’re betting on the price direction of the underlying asset.
Buy to Open Transactions
Buy to open lets the trader establish a position in an underlying security. This type of transaction occurs when a trader wants to purchase a call or put option.
- Call options – For a call option to profit, the underlying security price must increase enough to push the call option price past the break-even point.
- Put options – For a put option to profit, it must fall enough to drive the put option price below the break-even point.
- To close out the trade, you must buy the call or put option back using a sell to close transaction order.
Sell to Open Transactions
Sell to open transactions occur when an options investor initiates an options trade by selling or establishing a short position in a call or put option.
Buy to Close Transactions
The buy to close transaction order is used to close out an existing options trade. This occurs when a trade is originally opened using a sell to open transaction order. A trader initially sold a call or a put. However, this created a short position regarding the underlying security. In order to exit the trade, the buy to close transaction order closes out the short position.
- Call options – For a call trade to profit, the underlying security price must remain below the option’s sell to open price.
- Put options – For a put trade to profit, the underlying security price must fall enough to drive the put option price below the break-even point.
Sell to Close Transactions
Sell to Close is the opposite of a buy to open trade. To close out the trade, you must buy the call or put options back using a sell to close transaction order.
Example of a Sell to Open Transaction
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. (Source: ibid)
Up Next: What is an NSF Fee for Non-Sufficient Funds?
An NSF fee describes the fee charged when a check is presented but cannot be covered by the balance in the account. The term NSF stands for non-sufficient funds or insufficient funds. It refers to the status of a checking account that does not have enough money to cover transactions. An NSF fee is charged when a check is presented but cannot be covered by the balance in the account. You may see a “non-sufficient funds” or “insufficient funds” notice on a bank statement. You may also the notice at an ATM terminal or on a receipt. This occurs when you attempt to withdraw more money than your account holds.