What is Buy To Open?

431 reads · Last updated: December 5, 2024

"Buy to open" is a term used by brokerages to represent the establishment of a new (opening) long call or put position in options. If a new options investor wants to buy a call or put, that investor should buy to open. A buy-to-open order indicates to market participants that the trader is establishing a new position rather than closing out an existing position. The sell to close order is used to exit a position taken with a buy-to-open order.Establishing a new short position is called sell to open, which would be closed out with a buy-to-close order. If a new options investor wants to sell a call or a put, that investor should sell to open.

Definition

Buy to open is a term used by brokers to represent the establishment of a new (opening) bullish or bearish position in options. If a new options investor wants to purchase a call or put option, they should choose buy to open. A buy to open order informs market participants that the trader is establishing a new position rather than closing an existing one.

Origin

The concept of buy to open emerged with the development of the options market. Options trading can be traced back to the 17th-century Dutch tulip bubble, but the modern options market matured after the Chicago Board Options Exchange was established in 1973. Buy to open became a standardized trading term to help investors clarify their trading intentions.

Categories and Features

Buy to open primarily includes buying call options and buying put options. Buying a call option means the investor expects the underlying asset's price to rise, thus purchasing a call option to buy the asset at a lower price in the future. Buying a put option means the investor expects the underlying asset's price to fall, thus purchasing a put option to sell the asset at a higher price in the future. The advantage of buy to open is that the risk is limited, with losses confined to the option premium paid, but the potential gains can be significant.

Case Studies

Case 1: In 2020, Tesla's stock price surged, and many investors profited by buying call options. For example, an investor bought a call option when Tesla's stock was $300, with a strike price of $350 and an option premium of $10. When the stock price rose to $400, the investor exercised the option, buying the stock at $350 and selling it at $400, making a $40 profit (after the option premium).

Case 2: In 2022, a tech company faced market uncertainty, and investors expected its stock price to fall, so they bought put options. Suppose the company's stock was $150, and an investor bought a put option with a strike price of $140 and an option premium of $5. When the stock price fell to $130, the investor exercised the option, selling the stock at $140, making a net profit of $5 (after the option premium).

Common Issues

Common issues investors face when using buy to open include neglecting the option premium, leading to underestimating costs, and incorrect market trend predictions, resulting in the option expiring worthless. Investors should carefully analyze market trends and consider the impact of the option premium on overall investment returns.

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