What is Buy To Open?
“Buy to open” is a term used by brokerages to represent the establishment of a new long call (opening) or an option sales position. An open buy order tells market players that the trader is establishing a new position rather than closing an existing position. The “sell to close” order is used to exit a position taken with a buy order to open. The establishment of a new short position would be labeled “sell to open”, which would be closed by a “buy to close” order.
Basics of purchasing to open
The buying and selling terminology for option trading is not as simple as for stock trading. Instead of simply placing a “buy” or “sell” order as they would for stocks, traders must choose between “buy to open”, “buy to close”, “sell to open” and “sell. to close”.
A purchase to open a position may indicate to market participants that the trader initiating the order believes something in the market or has a particular ax to grind. This is especially true if the order is large. However, this should not be the case, as option traders frequently engage in spread or hedge activities where an open purchase can actually offset existing positions.
Under certain market conditions – for example, if a stock with options is to be delisted or is suspended for an extended period – the stock exchange may declare that only close orders will be issued, and therefore a buy order at the opening would be refused.
Buy to close in stock
Buy to open also applies to stocks. When an investor decides to establish a new position on a particular security, the first purchase transaction is considered a purchase to open because it opens the position. By opening the position, the security is established as an investment in the portfolio. The position remains open until closing with the sale of all stocks. This is known as the closing sale because it closes the position. Selling a partial position means that some, but not all, inventory has been sold. A position is considered closed when there is no longer any particular action or exposure to it in a portfolio.
Closing buy orders also come into play when hedging a short position. A short sale position borrows the shares through the broker and is closed by buying back the shares on the open market. The last transaction to close the position completely is known as the buy order to close. This completely removes the exposure. The intention is to buy back the shares at a lower price to generate a profit from the difference between the short sale price and the closing purchase price.
In some cases, when the stock price rises, the trader may have to buy to close at a loss to avoid even greater losses. In the worst case, the broker can execute a forced liquidation following a margin call – a broker’s request that an investor put money into his margin account due to a shortfall. gain – which would generate a purchase to cover the order to close the position at an amplified loss due to insufficient equity.
Key points to remember
- The Buy to Open position is generally used by traders to open positions in a given option or action. A close short position is generally used to close the position.
- A Buy to Close position occurs during a short sale when a trader buys the shares he has sold on the open market. In some cases, when the stock price rises, the trader may have to buy to close at a loss to avoid larger losses.
Example of purchase to open
Suppose a trader has done their analysis and thinks that the price of XYZ shares will increase in the near future. She buys stock options by placing a Buy to Open order.