Definition and Example of Buy To Open
Buy to open refers to establishing a position in a derivative like an option. Specifically, it means buying an option to create your position. This is in contrast to selling an option to establishing an open position in that option.
Many investors use their brokerage accounts to buy stocks, bonds, and other investments directly. Investors can also purchase other types of securities in their brokerage, like derivatives such as options. This gives you the right but not the obligation to sell certain securities or futures, which requires that the buyer buy the securities by a certain date. When you open a position in options or futures, you are buying to open.
Note
There are two types of options that you can buy: calls and puts. Investors who believe a stock will rise may want to buy a call option, which gives them the right to buy shares at a set price. If they think the price of the shares will drop, a put option gives them the right to sell shares at a set price.
For example, if XYZ is trading at $50 and you think that the shares will gain value, you might decide to submit a buy to open order for calls. You can choose the number of contracts to purchase and the strike price of those contracts.
Most options contracts cover 100 shares of the underlying security. If you buy 10 calls, you have the right to sell 1,000 shares at the strike price.
You could submit a buy to open order for 10 call options with a strike price of $53. If XYZ rises above $53 before those options expire, you can exercise them to earn a profit.
How Does Buying To Open Work?
Buying to open works by giving you ownership of a derivative. For example, if you submit a buy to open order for put options, you’re buying put options that give you the right to sell shares for a specific price.
You’re said to be opening a position because owning those contracts puts you in a position where you can profit from movements in the underlying security.
Once you have an open position, you will eventually have to close it. An options position automatically closes once the contract expires. You can also exercise the option to close the position.
Note
Investors can also close their position by submitting a sell to close order. This sells the derivatives contracts they own to someone else who can then choose what to do with it. If the value of the contract has increased, selling to close can produce a profit.
Buy To Open vs. Sell To Open
| Buy to Open | Sell to Open |
| You need money to purchase derivatives | Can sell derivatives without needing cash to buy them |
| Potentially unlimited profit | Profit limited to the collected premium |
| Losses limited to the premium paid | Potentially unlimited losses |
Buying to open involves purchasing a derivative to open a position. Investors can also sell derivative contracts. Selling to open means opening a position by selling a derivative rather than buying one.
To buy options, investors need money to pay for the options’ premiums. By contrast, selling an option doesn’t require an upfront investment. However, selling a derivative means the investor only collects a premium payment when selling the contract, and they could lose large amounts if the underlying stock moves significantly in the wrong direction.
Note
Selling to open is generally riskier than simple buying because you have the potential for greater losses.
What It Means for Individual Investors
If you’re an investor who is interested in using derivatives, it’s generally safer to buy derivatives than to sell them. When buying options, your risk is limited so you don’t have to worry about unexpectedly emptying your account by selling an option that generates massive losses.
This means most investors who use options should primarily be opening positions using buy to open orders rather than sell to open orders.
Key Takeaways
- Buy to open in trading is when you open an options or futures position by buying a contract.
- Investors can later close their open position by submitting a sell to close order.
- Buying options is less risky than selling them, so using buy to open instead of selling to open orders is likely better for individual investors.
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