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One of the features of options trading is that it is really simple to open a position where you profit if the value of the contract falls. One of the order types that influence how an option contract is purchased or sold is the Sell to Open.
This article will explore Sell to Open order; the meaning, types, examples and more.
What is Sell To Open?
Sell to Open is an options trading order and refers to the initiation of a short options position by entering into or selling an options contract. When a person sells to open, they initiate a short option position. It is helpful to think of an open sale as “opening a put or put option contract”.
Sell to open Basis
Sell to Open refers to cases where an option investor initiates or opens an options trade by selling or short selling an option. This enables the option seller to receive the premium paid by the buyer on the other side of the trade. Options are a type of inferred collateral.
Selling to open an investor may be eligible for a premium by selling the opportunity associated with the option to another investor in the market. This causes the investor to take a short or short position while the second investor goes long or buys a security in the hopes that its value will go up.
The investor selling the position expects that the underlying asset or stocks will not exceed the strike price as this will allow them to hold the stocks and benefit from the long investor’s premium.
Two types of options
For each type of options contract, one part is long and one part is short:
The long part buys the call option and assumes that the price of the underlying asset will rise. A premium is paid for the right to purchase the Underlying at a specified price (the Strike Price) on or before the Expiration Date.
The short party SELLS the call option and expects the price of the underlying asset to decrease. Therefore, that party enters into an option contract by selling (sell to open). The ability to purchase the underlying asset at a set price on or before the expiration date of a premium.
The long part buys the put option and assumes that the price of the underlying asset will fall. A premium is paid for the right to sell the underlying on or before the Expiration Date at a specified price (the Strike Price).
The party with a short position sells the put option and expects the price of the underlying asset to rise. Therefore, that party enters into an option contract by selling (sell to open). The ability to sell the underlying asset at a set price on or before the expiration date of a premium.
If a party sells to open an option contract, a premium is received. The premium reflects the current market price of the options contract. The option premium is a combination of two factors: the external value and the internal value.
The extrinsic value is based on (1) the fair value, the time remaining until the option contract expires, and (2) the implied volatility, the amount that the underlying asset can move.
- The longer the expiry period of an options contract, the greater the time value and the resulting extrinsic value. The longer the term, the greater the probability that the underlying will exceed the strike price.
- The more volatile the underlying value of an options contract, the higher the extrinsic value. This, in turn, is due to the fact that the likelihood that the underlying asset will exceed the strike price increases.
The intrinsic value reflects how well the options contract is “in the money”.
- A call option has an intrinsic value if the price of the underlying is higher than the strike price.
- A put option has an intrinsic value if the price of the underlying asset is below the strike price.
Example of Sell to Open
Question: Tom anticipates that Company X’s shares will fall in the near future. What type of options contract and what type of trade order would be appropriate to take advantage of this speculation?
Answer: Tom needs to initiate a sell order to open call options in Company X.
Question: A call option has an exercise price of USD 50. The underlying asset is valued at $ 45. However, the premium is currently $ 5. Where does the premium come from?
Answer: If the price of the underlying asset in a call option is below the strike price, there is no intrinsic value. The option premium results exclusively from the external value, ie the time value and the implied volatility.
Sell to Open Vs Sell to Close
Sell to open orders
A sell to open order is an order in which you short a new options contract. This can be a sale to open a call (bearish trade) or a sale to open a put option (bullish trade).
Since options contracts are bought and sold by market participants in a market, this means that participants can buy/sell an existing contract or create their own contract.
With a sell-to-open order, you create a new options contract (known as a “draft” contract) that another options trader will buy from you.
When you write an option, you give the option buyer the right, but not an obligation, to buy the underlying security from you at an agreed price.
If the option holder exercises his or her right, you are obliged to sell the security to him at the exercise price regardless of the actual price of the security.
With this type of contract, there are different approaches to handling the transaction, depending on whether it is a call or a put option.
When you use a Sell-to-Open option, your goal is a fall in the price of the underlying security.
In this case, you have two options for monetizing the position. First, simply buy the contract because the underlying asset has lost its value.
Second, the option holder not to exercise their right to purchase the underlying assets and the contract will expire worthless.
If you instead use a put option to sell, your goal is to increase the price of the underlying security. In this case, the value of the contract is reduced and you can buy it back at a profit before it expires.
Sell to close
Although it looks very similar, the Sell to Close is fundamentally different from the sales order to be opened.
In comparison, Sell to Close is used to sell an existing options contract that you already own and is used for both call and put options.
With call options, the value of the contract increases as the price of the underlying stock increases, and vice versa with put options.
If you have a call option and the underlying share price rises, you can hold it to maturity and exercise your right to buy the agreed amount of the underlying stock at the agreed strike price.
In this case, you will receive the underlying stocks and can own or sell them immediately for a profit.
A simpler approach to profiting from the position (and how most options traders work) is to simply sell the options contract before it expires.
All you have to do is execute a Sell to Close and your position will be closed with the profits automatically added to your brokerage account.
This saves you from buying and selling the underlying stocks and allows you to take advantage of profitable movements before the expiration date (at which point a position could be reversed).
A Sell to Open is used when an options trader wishes to benefit from a decrease in the value of the contract. It creates a new options contract that is bought by another trader.
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