Buy to Open vs. Buy to Close: Investment Guide

If you’re going to invest in options trading, you’ll need to know some basics. Buying to open is when you purchase a new options contract and assume either a long or short position. Conversely, buying to close is when you purchase an existing options contract that matches a contract you sold. In doing so you offset your existing contract and exit your position. Here’s a closer look at buying to open and buying to close.

A financial advisor can help you navigate the complex world of options trading.

Options Contracts Basics

An options contract is a financial product known as a derivative, meaning that it takes (or “derives”) its value from some underlying asset. The owner of an options contract has the right to trade the contract’s underlying asset for a given price (strike price) on a given date (expiration date). This is a right, not an obligation. If the owner of an options contract doesn’t want to make the trade, they don’t have to.

There are two parties to every options contract: the holder and the writer. The holder of a contract is the party who bought it and has the right to exercise that contract’s option. The writer of a contract is the party who sold it and has the obligation to fulfill its terms if necessary.

Furthermore, there are two types of options: calls and puts.

What Is a Call Option?

A call option gives its holder the right to buy an asset from the writer. This is a long position, meaning that the holder is betting that the asset’s price will go up.

For example, say you have an options contract. It is a call option for XYZ Corp. stock at $15 with an expiration date of Aug. 1. On that date, you, the holder, have the right to buy shares of XYZ Corp. from the writer for $15 per share. If, say, the price of XYZ Corp. shares has increased to $20, they will still have to sell you those shares for $15 regardless of their current worth.

What Is a Put Option?

A put option is the opposite. It gives its holder the right to sell an asset to the writer. This is a short position, because the holder is betting that the asset’s price will go down.

For example, say you hold a put option for XYZ Corp. stock at $15 with an expiration date of Aug. 1. This means that on Aug. 1, you have the right to sell shares of XYZ Corp. stock to the writer for $15 per share. If, say, XYZ Corp. shares have dropped to $10 per share by then, the writer will have to buy those shares from you for $15.

What Is Buying To Open?

Buying to open is when you enter a position by buying a new options contract. The writer creates a new contract and sells it to you for a set price, known as the premium, and you now have all the rights of that contract. Since this is a new position, it also creates a new market signal based on your particular bet for or against the underlying asset.

This can apply to both call and put contracts.

If you buy to open a call contract it means that you have bought a new call contract from the seller. This gives you the right to buy the underlying asset from the seller at the expiration date for the strike price. It signals to the market at large that you think the asset’s price will go up.

If you buy to open a put contract it means that you have bought a new put contract from the seller. This gives you the right to sell the underlying asset at the expiration date for the strike price. It signals to the market at large that you think the asset’s price will go down.

In both cases, you now own the options contract. This is called buying to open because it opens a position that did not exist before, making you the holder of a new contract.

What Is Buying To Close?

Buying to close is when a contract writer exits their position by buying an equal-and-opposite contract.

When you write and sell an options contract, you’re entering a new position. In exchange for an up-front payment, called the premium, you assume the responsibilities of this contract. In a call contract, this means that you have to sell someone the underlying assets if they choose to exercise their option. In a put contract, you have to buy the assets if they exercise their option.

This is good in that you get paid for taking that risk, but it’s still a risk. If the asset price doesn’t move the way you expected you can be on the hook for those losses.

For example, say that you sell a call contract for XYZ Corp. stock. The expiration date is Aug. 1 and the strike price is $50. If the buyer chooses to exercise the contract, then on Aug. 1 you must sell shares of XYZ Corp. stock for $50 per share. If, say, XYZ Corp. stock is selling for $60 per share at the time, you would lose $10 per share on that contract.

To eliminate that risk you can exit your position by buying a new contract identical to the one you sold.

In our example above, you would go to the market at large and buy a call contract for XYZ Corp. stock with an Aug. 1 expiration date and a strike price of $50 per share. You now hold offsetting positions. For every $1 you may potentially owe the buyer, the contract you hold will pay you $1. For every $1 you can make off the contract you hold, you will owe the buyer $1. The contracts cancel each other out, leaving you with a net-zero position.

Buying the new contract will cost you a premium, which will most likely be more expensive than the premium you collected for selling the first contract, but you will have exited the position.

Role of the Market Maker

To understand why this works, it’s important to remember the role of a market maker.

Every major market goes through what’s known as a “clearing house.” This is a third party that takes in all transactions, equalizes them and then makes all collections and payments as necessary. With options, this means that everyone buys and sells their contracts to and through this market.

For example, say you buy a contract from the market. If you exercise the option, you collect his money from the market at large, not from the writer directly. The opposite also holds true. The writer might write the contract you’re holding, but they sell that contract to the market. If they owe money on it, they pay that money to the market.

The result is that all debts and credits are calculated against the market at large. The writer doesn’t owe you $500, they owe $500 to the market. The market, in turn, pays you the $500 that your contract is worth.

This is what makes buying to close work. When you write an options contract, you hold this position against the market at large. When you buy a new, offsetting position, you buy that from the market at large, as well. Regardless of who holds the contract that you wrote, the market maker will pay and collect everyone’s money equally. The result is that for every $1 you owe to the market, the market will owe you $1 and you will end up owing and collecting nothing.

Cost and Risk Considerations

Trading options involves more than just anticipating market movements, it also means understanding the costs and risks associated with each trade. When you buy to open a contract, the most immediate cost is the premium, the price you pay to acquire the contract. This premium represents your maximum potential loss as a buyer, making the risk capped and known upfront.

However, buying to close is often done to exit a position you previously opened by selling an option. In this case, the cost of buying to close may exceed the premium you initially collected, especially if the market has moved against your position. This is particularly important for traders who have sold naked or uncovered options, where the potential losses can be theoretically unlimited. Buying to close can help you limit or prevent those large losses.

Another important factor to consider is the bid-ask spread. A wider spread can increase the overall cost of entering or exiting a position, especially for less liquid contracts. Liquidity can also be an issue. If the options contract you’re trying to close is thinly traded, you may have difficulty finding a buyer or may have to accept a worse price to exit the position.

Also factor in commissions or per-contract fees, which vary by brokerage and can add up quickly for active traders or complex strategies involving multiple legs.

Tax Implications of Options Trading

The IRS generally treats gains and losses from options trading as short-term capital gains, which are taxed at a higher rate than long-term gains. This applies whether you close a position early or let the contract expire. If you buy to open and then sell to close, any profit will be considered short-term unless the contract was held for more than a year, something uncommon in options trading.

If you buy an option that expires worthless, you can claim a capital loss equal to the premium you paid. Conversely, if you sell a contract and later buy to close it at a higher price, the difference represents a short-term loss. The IRS considers options gains and losses realized on the date the contract is closed or expires, not when it was purchased or sold.

For writers of options, the rules can be more complex, especially if the contract is exercised or assigned, affecting how and when gains are recognized.

Because tax implications can vary based on your trading activity and individual situation, it’s best to consult a qualified tax advisor or financial professional to understand how options trading fits into your overall tax strategy.

Bottom Line

Buying to open is when you buy a new options contract and enter a new position. Buying to close is when you buy an options contract that offsets a contract that you wrote, allowing you to exit your position. Also, keep in mind that all profitable options trading results in short-term capital gains, so plan your taxes accordingly.

Tips on Investing

Options can be a speculative, but potentially profitable, section of the market. A financial advisor can help you determine whether options trading is right for you. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
If you’re going to be trading options, it’s important to understand how these derivatives are taxed. Be sure to give our options taxation guide a read before diving into these transactions so you’ll know the tax implications going in.