Sell To Open Orders
Options trading can seem like a very complex subject to beginners, and there is certainly much to learn if you want to be a successful options trader. There are many different types of options for example, and several types of options orders that you can place. It is, in fact, the variety of different orders that often puts people off getting involved with options trading as it just seems so complicated. While there are certainly a lot of different orders that can be used in options trading, there are actually only four main types that you absolutely need to understand.
The sell to open order is one of those main types, and is used to open a position by short selling contracts. The other way to open a position is to use a buy to open order, but that involves buying options contracts rather than short selling them. When using the sell to open order you are actually writing new options contracts which are then bought by other options traders. The sell to open order should not be confused with the sell to close order, which is used to sell options contracts that you already own.
Using Sell To Open Orders
The sell to open order is used to write new options contracts that you sell in the belief that their value will go down. When those contracts are sold on the market, then you receive the sale price. There are two main types of options contracts that you can write – call options and put options.
When writing call options contracts, you are giving the person who buys those contracts – the holder – the right to buy the relevant underlying security from you, at agreed strike price. If the holder decides to exercise their option and buy the underlying security at the strike price then you are obliged to sell it to them at that price, regardless of what the current price of the security is.
If you do not physically hold the underlying security when the holder exercises their option, then you will have to buy it at the current price before selling it to them at the strike price. If the price of the underlying security has gone up, then obviously you will have made a loss. Therefore you would sell to open call options when you anticipated that the underlying security would fall in price. There are two ways that you can make a profit by through writing call options; either by buying back those contracts should they fall in value or if the holder does not exercise their option and the contract expires.
For example, if you have written call options - using the sell to open order – on a specific underlying security, and that security goes down in value, then the options contract will also go down in value. You can then buy those contracts back using the buy to close order, thus closing your position and taking any profits at that point. You may prefer to leave your position open, as if the underlying security does not go back up then there is no reason for the holder to exercise their options and the contracts will expire worthless, and your profit will be the amount you sold the contracts for in the first place.
When writing put options, you are granting the holder the option to sell you the underlying security at a fixed strike price. If the holder chooses to exercise their option, then you are obliged to buy the underlying security from at the agreed strike price.
Options traders buy put options when they believe the underlying security is going to go down, therefore you would use the sell to open order to write put options if you expected the underlying security to go up in value. Should the underlying security increase in value, then you would be able to use the buy to close order to buy the options contracts back and make a profit.
Many beginner options traders make the mistake of assuming that the sell to open order can only be used to take a short position on the underlying security, but this is not true. The sell to open order is used to take a short position on the options contracts written, meaning that you would make money if the options contracts go down in value. Put options contacts go down in value when the underlying security goes up, so if you write put options contracts using the sell to open order then you are effectively going long on the underlying security.
In summary, the sell to open order is used to establish a short position by writing new options contracts. If you write call options contracts then you make money when the underlying security goes down, and lose money when it goes up. If you write put options contracts then you lose money when the underlying security goes down, and make money when it goes up.
How to Place Sell to Open Orders
To write new options contracts using the sell to open order you will need to use the services of an options broker. An options broker will sell the contracts you write on your behalf, and the proceeds will be added into your account. You can then also use the broker to buy back those contracts if you want to do so at any point. Brokers will charge you commissions on every order that you place, and the cheapest commissions are typically available from online options brokers.