Buy To Close Orders
There are so many different types of options orders that many beginners find themselves overwhelmed, and it can even cause people to stay away from the whole idea of options trading in general. However, if you are prepared to take some time to learn how options really work, then it will be much easier to understand the various types of options orders, how they work, and what they are used for. When you first started options trading you don’t really need to know about each and every one of the different options orders you can use, but you should make sure you are familiar with the main types.
The buy to close is one of the four main types of options order that can be used to trade options contracts. Like the buy to open order, the buy to close order is used to purchase options contracts, as opposed to the sell to open order or the sell to close order, which are both used to sell options contracts. The buy to close order is an order that is used to close an existing position where you have short sold options contracts and it's similar to when you buy stocks having short sold them.
Using Buy To Close Orders
The buy to close order essentially has just one purpose: to close out a position you have open because you short sold your options contracts. If you have originally placed a sell to open order on options contracts then you would have actually created new options contracts and sold them to a market maker, thus opening your position and giving yourself the obligation to honor the option in those contracts if the holder of them decides to exercise their option. To remove yourself from that obligation, you can place a buy to close order to buy back those contracts and close your position.
There are a number of circumstances under which you might choose to use a buy to close order to exit your position, and this would of course depend on what options trading strategies you were using. For example, if the options contracts you created have gone down in value, then you may choose to buy those options contracts back at the lower price using a buy to close order, and realize your profits at that point. Alternatively the options may have gone up in value, and to cut your losses you place a buy to close order to buy the options contract back.
There are various types of options contracts that you can write using a sell to open order and therefore sell using a buy to close your order. The type of options contracts that are involved in your open position would affect at what point you choose to place a buy to close order: either call or put options.
For example if you have sold call options contracts, you have given the holder the right to buy the underlying security at a fixed strike price. The price of those options contracts would rise if the underlying security went up, and would fall if the underlying security went down. If you had sold put options contracts then you have given the holder the right to sell the underlying security at a fixed strike price. This means the options rise in price when the underlying security goes down and they fall in price when the underlying security goes up.
It's imperative that you understand the differences highlighted above, as this clearly affects whether your position is in profit or in loss which in turn affects at what point you will use a buy to close order to exit that position. As you have taken a short position, you are in profit when the price of options has gone down and at a loss when the price of options has gone up. A buy to close order can be used to close your position whether you are in profit or loss, but you obviously need to be clear which it is so that you make the right decision. This shows how important it is to understand the different types of options orders and how they work.
How to Place Buy To Close Orders
Buy to close orders can be placed with any options broker, and they will execute the transaction on your behalf. There are many different options brokers out there but in very general terms they all offer the same kind of services. Although the fees and commissions that they charge can vary. The cheapest services are typically offered by online options brokers who tend to be deep discount brokers with very competitive commission structures.