Online trading is expected to reach a market value of $15.34 billion by 2030. The market has been steadily growing since it first emerged. But it was not until the global pandemic that it saw a boom.

A strong desire for freedom coupled with rising global inflation is one of the driving forces leading thousands to stock investing. But as it is with the financial industry, trading is marred with heavy jargon that is hard to understand, especially for new traders.

As a new trader, you have probably heard of the terms buy to close or buy to open. What do they mean? In this article, we will dissect the two terms. We will give you a clear comparison between these two accompanied by clear examples.

What Is an Option?

Before we expound the two terms, let’s first gain a bit of clarity on options.

An option is a contract or agreement between an option holder (buyer) and an option writer (seller). The contract outlines the sale price or strike, and the option duration. The option duration is the time the option holder has to purchase the known asset.

There are two categories of options: European and American. An American option can be executed at any time in the option time frame. However, a European option only comes into effect at the end of the option duration.

Imagine you want to sell your house at $990,000. A friend approaches you and expresses interest in buying your home. Your comrade asks you for time to get the money together. You agree to give this friend three months to raise the funds.

To further express interest your friend gives you a $19 800 premium. For the next three months, you cannot sell your house to anyone else. Your friend bought the exclusive right to purchase your home within the preset time frame.

The two traded options are call options and put options.

Call options are the holder’s right to purchase an asset while put options are the holder’s right to sell an asset.

What Is to Buy to Open?

Buying to open is a trading technique used to open a new position. Opening a position means you are creating a new contract. Every trading dashboard starts at zero. But after your purchase, you will be in a positive position. And after selling you will be in the negative.

Once you have opened a position, your dashboard will summarize the call or put that you purchased. Buying to open is regarded as a long-term trading play. However, if you would like to close this position and get back to zero, your move is to sell to close.

Buying to Open Example

You see a “KX” stock trading at $170. After reviewing price trends from several months, you conclude that the price will remain bullish.

You predict that the price will rise above $200 in the next four months.

Chances are that the seller believes the stock is headed in a bearish direction. You can enter into a contract with the seller allowing you to buy the stocks at a strike price of $200 within the four months.

This gives you the right to buy the stocks at $200 even if they have risen to $250.

Sell to Close

Sell to close is a position assumed by a buyer when they are ready to close a contract. This step follows the buy-to-open pathway.

Say you bought six stocks at $75 with a strike price of $130. The option duration is ten days from expiration. To sell to close, you will have to find a buyer in the option pool who is willing to buy the contract. This way, you sell your contract to close the position.

What Is Buy to Close?

Much like selling to close, buying to close is the route traders take to close a position. At this time, for whatever reason, you want to exit an existing contract. Buying to close will allow you to subtract yourself from a contract.

Buy to Close Example

Think of it this way: You had five X.Inc stocks trading at $90 each. And you sell these stocks to Gabby with a $180 strike price. The contract is closing in 40 days. Within the option duration, the stock price rises to $200.

This will put you at a loss. To offset these effects, you must find a similar contract that will cancel out this existing one.

You need to buy a new contract to close this existing contract. In the options pool, you find stocks that are 40 days out with a trading price of $90 each. The contracts must also possess a $180 strike price.

Once you have completed this transaction, you have canceled your contract with Gabby. This means your seller and Gabby are now in a contract. What you have done is buy a contract to close the contract you already had.

Sell to Open

Selling an option to open a position is a trading route often paired with buying to close. In the selling-to-open scenario, you are initiating a position. What you are doing is entering into a new contract.

If you want to close this contract, you would have to buy to close.

Trading Tips for Day Traders

Day trading is turbulent territory. It is a space that demands caution for all traders, but more so for new traders.

We have tips to help you weather the trade market:

  • Study the market
  • Understand your position
  • Try different strategies like scalping and high-frequency trading

If you need trading advice or live coaching, day trading leaders like My Investing Club can help.

Learning the Difference Between Buy to Close vs. Buy to Open

Buy to close or buy to open? No technique stands above the other. Both these trading routes, when paired with the right strategy will yield profit. They are both used to trade calls or puts. There are some differences worth noting.

Buy to open establishes a new position while buy to close is employed to close an existing contract. The former is ideal for long contracts and the latter best for short-term positions. Talk to licensed traders and explore your options.