Buy To Close Meaning
Buy to Close refers to a strategy mainly used by options traders for exiting short positions in the stock market. In short, traderstryto terminate an open position by writing an option for which they have earned a net credit. Traders use this strategy to purchase an asset to counterbalance and end the short position concerning the same asset.
Investors and day traders have been using this strategy to get out of open positions at a time when they get an option position at net short. It decreases the number of option contracts available in the market. One can consider it as a type of offsetting trade covering short positions. Day traders can thus eliminate the possibility of a future price increase.
Table of contents
- Buy to Close (BTC) Meaning
- Buy To Close (BTC) Explained
- Example
- Buy To Close vs Sell To Close
- Frequently Asked Questions (FAQs)
- Recommended Articles
- Buy to Close is an options trading strategy where trading one's portion forms a part of an already current option.
- The moment a day trader executes a buy-to-close order that debits the account and writes an option to aggregate the option premium (net credit), that trade is considered to be in the buy-to-close position.
- It allows the day trader to take advantage of time decay and profit from the selling by hiking the premium as high as possible between buying to close and writing the option contract.
- The major difference between 'buy to close' & 'sell to close' occurs due to the former terminating a day trader's obligations. In contrast, the latter terminates the rights of a trade related to an options contract.
Buy To Close Explained
Buy to Close optionrefers to paying for someone else to occupy one's place till the expiration of the options contract. In other words, day traders remove themselves from the current options contract and close their position at risk. They can also buy to close a put option. Understand it asatrader trying to sell, closing out, then going for a put or call option.
A buy-to-close begins as soon as a day trader writes an option that aggregates the option premium, sometimes termed as the net credit, while acting on an order that debits the account. It happens because the options trader tries to profit from the selling by hiking the premium as high as possible between buying to close and writing the option contract. Day traders undertake the route of shorting a stock and then covering it.
Moreover, buying option allows the completion of a short option. It impacts in a negative manner that gets the open interest reduced upon its execution. The day trader wisely buys back the option when the option remains a little lower than the purchase price. As a norm, buying too close gets triggered only after the option writing. Moreover, writing cum option selling gives a trader the advantage of time decay.
Day traders must do it because buying to close option becomes a highly risky strategy when implemented without any hedging position; otherwise, huge losses can hamper traders' profitability and investment. Moreover, it underlines that writing calls entail infinite risks, whereas writing put options gets risky only when the stock falls to zero. As a result, wiring becomes more valuable than wring buying to buy to close call optioncontract.
Example
Let us assume that a day trader Alex has done an opening position using writing that puts upon Amacon Ltd. stock having a current share price worth hundred dollars. Trader Alex believed that the related stock price would rise or remain flat. As a result, they deployed the strategy of neutral to bullish after selling every option contract.
Day trader Michael could also sell options believing implied volatility could drop. The $100 strike having one-month expiration puts generated an $8 credit. Just before the day of the option's expiry, the stock trader approaches the benchmark without any price change concerning the point where it used to be a month ago, which is at $102.
Given that the strike price remains just under the stock price even though there isn't much time left before delivery, the put contract's value has fallen significantly. As a result, the trader gets profit through purchasing at a value close at a profit of $2 just before its expiry day. Hence one can see that trader had sold the option to open at $8; after this trader, Michael bought it at close to $2, creating a profit of $6.
Buy To Close vs Sell To Close
Let us understand the difference between buy to close and sell to close in a tabulated form as below:
| Buy to Close | Sell to Close |
| It means those orders that allow buying back of an asset previously short-sold by a day trader. | Sell to Close means day traders try to come out of the long position of the option. |
| It leads to zero vulnerability of the asset to the market. | It provides the desired exposure to the asset. |
| Buy to close gets considered as the corresponding action of sell to open. | Sell to Close gets considered as the corresponding action of buy to open. |
| All actions of closing the short positions get termed as buy-to-close covered calls. | All actions of closing the long option trades get called sell to close. |
| It provides an end to all obligations related to the options contract. | In addition, it provides an end to all rights related to options contracts. |
| It tends to be an option contract that one opens by selling. | It tends to be an option contract that one opens by purchasing. |
Frequently Asked Questions (FAQs)
When to buy to close a put option?
It gets used when the day trader falls in the net short of an option position but still wants to quit from that open position.
What is buy to close and sell to open?
Buy to close means that the day trader closes the put or call option that they had sold, whereas sell to open gets referred to starting a short option position through selling or writing an options contract.
When to buy to close a covered call?
When the stock price has significantly surpassed the short call, tradersclose covered calls because that often generates close to the maximum profit. Conversely, traders consider terminating a covered call if the stock price declines considerably and the presumption changes.
Recommended Articles
This has been a guide to Buy To Close and its meaning. Here, we explain it in detail with its example and comparison with sell to close. You can learn more about finance from the following articles -
- Panic Buying
- Buy-Stop Order
- Options On Futures
