To understand the answer to, “How to Buy to Open vs Buy to Close”, we must first understand how an options contract works. When an investor purchases this contract from an option broker, that contract becomes known as an open option. This means that the investor can buy or sell at any point up to the expiration of the contract. At the time of the purchase, the seller of the option will have no obligation to sell and will not receive a fee for the option. The exact opposite is true of the close option. When an investor purchases this option from an options broker, the contract becomes known as a close option and the buyer will receive a fee.
Now let’s examine the advantages of both a buy to open and a buy to close order. With a buy to open order, there is no commitment on the part of the investor to buy the underlying security. Since the investment is speculative, it relies solely on the timing of an economic indicator. Should the economic indicator tip the market in favor of the seller, the investor would exercise the option and purchase the security. If, on the other hand, the indicator tip the market in favor of the buyer, the investor would then exercise the option to buy the underlying note. It is similar to the popular practice known as speculating on currency.
The advantage of a buy to open order is that it is easier to implement during volatile markets. An investor may decide to buy to mitigate risk. Or he may buy to take advantage of a short-term trend. Whatever the reason, it is usually easier to implement this form of trading because it is not restricted by the requirements of a traditional exchange.
On the other hand, a buy to close order is executed in a traditional exchange. It requires an investor to purchase the underlying note prior to exercising the option. After all, the price cannot be determined simultaneously by an investor and by the exchange. The only thing that matters is whether the price goes up or down. If the difference between the prices is more than the strike price, an option will be exercised.
The benefit of this kind of option is that you do not have to wait for the market to make the decision for you. You don’t even have to be in front of a computer screen. In fact, it is more convenient for you to purchase a call or put option, put in order, and close their corresponding positions at the same time. This eliminates the need to go to your broker and enter the numbers.
Buy to close transactions are executed by an option writing company. As with the case of put options, the only thing that matters is whether the price goes up or down. The trader does not have to wait for the right time to enter the position. He can simply write a call or put option contract. Once it is purchased, the trader has no further obligation regarding the price or position duration.
It is important that you take note that the price cannot be determined simultaneously by an investor and by the exchange. The only thing that matters is whether the market is in the buy mode or in the cell mode. If the market is already closed, it is not feasible to buy or sell and you must wait for the market to open again. On the other hand, if the market is open, there are opportunities to buy the derivative at a lower price and then set the strike price equal to the difference between the bid and the asking price. This is how you can gain entry into the position.
An option is a contract that allows the buyer a right but not an obligation to buy a particular underlying asset at a certain price during a specific period of time. The basic structure of this agreement is a promise to buy at a certain price on or before a certain date. This means that the buyer is placing a temporary option. The trader will profit from the difference between the bid price and the asking price if the option is exercised and the difference is more than the initial deposit made. Option trading strategies are very complex and it is best that you talk with an expert before you decide to buy to open vs buy to close.