Buy To Close – What It Means To ‘Buy To Close’
What does Buy To Close Mean?
In the world of trading there are numerous transactions one will make throughout the process of making a trade.
When a trader first decides to make a trade, he or she will pick the stock – or other trading vehicles for example and option contract – and then will in most cases use a broker account to place the trade.
When the investor makes the initial transaction to purchase a stock, or option, or other type of trading vehicle – that initial transaction can be referred to as ‘buying to open the position’ – or – ‘buy to open’.
This is because this when they are making this initial transaction (where they are purchasing the shares the shares of stock or option contract) they are ‘opening the position’.
They are ‘buying to open’ the trading position.
Then, when the trader is ready to close that position, they will ‘sell to close’ the position.
This part of the transaction is referred to as ‘selling to close’. This is because they have the position open. Then, when they are ready to sell the shares of stock or the option contract – they ‘sell’ the shares (or option contract) to close the position.
The trader will ‘sell to close’ the position.
However, if an investor ‘sells’ shares of stock or an option contract to open the position, that particular transaction is referred to as ‘selling to open’.
It is possible for traders to initialize a trading position by ‘selling’ first.
Shorting Stock
One example is if the investor is shorting stock.
This strategy involves selling shares of stock FIRST.
Why would an investor start off a position by ‘selling’ shares of stock instead of buying them?
An investor would sell shares if they believed that the stock they were trading would be dropping in value.
If the investor sold the shares first, and the underlying stock DID drop in value, the investor could then buy back those shares at a lower price after they dropped in value and make a profit in the process.
It is basically the exact opposite – or ‘flipped’ version of how most people think about trading in the stock market.
The trader sells the shares first – then after the stock drops – they buy at a lower price.
In doing so, they make a profit.
When a trader makes this type of trade – they have ‘sold to open’ the position – and then ‘bought to close’ the position – where the term ‘buy to close’ comes from.
Shorting Options
And investor can make the same type of transaction when trading options.
An investor can start off a trade by ‘selling’ an option contract first – and then ‘buying’ it back to close it at a later time.
This is referred to as ‘buy to close’.
Buy To Close Example
Let’s look at an example.
Let’s say that trader Bob thinks that stock XYZ is going to be making a move down over the next several weeks.
In order for Bob to profit from the expected drop in price, he decides to ‘short’ the stock. This is another way of saying he will sell shares of XYZ to open a position and then buy the shares back later to close the position.
So Bob calls his broker and ‘sells to open’ 100 shares of XYZ stock.
At this point, Bob is now ‘short’ XYZ stock – meaning he has a position that will benefit from a drop in the share price of XYZ.
It turns out that Bob was correct in his prediction and XYZ drops in price all the way from $100 per share all the way down to $80 per share.
Having made a nice profit on the drop, Bob decides to book his profits and close out the trade.
So he calls his broker and puts in an order to ‘buy to close’ his short position.
In doing so, his broker buys back his shares of XYZ at the lower price and closes the position.
Bob makes a profit on the difference in price.
He first sold to open the position at $100.00
Then he bought to close at $80.00
Another way to think of this transaction is that it is simply a traditional stock purchase and sell in ‘reverse’.
You can think of it as if Bob bought XYZ at $80.00 per share and then sold XYZ at $100.00 per share.
This is essentially what he did – only he did in in ‘reverse’.
