Quick Answer
Buying or selling to open creates a new long or short position and increases open interest; buying or selling to close eliminates an existing position and decreases open interest. Every option position ends one of three ways: an offsetting closing transaction (most common), exercise and assignment, or expiration.
With the Options Clearing Corporation (OCC) guaranteeing every trade, you can freely enter and exit options positions. Understanding the four basic transaction types (and the three ways a position can end) is essential for working options questions.
What Are the Four Basic Transactions?
| Transaction | Description | Effect on Position |
|---|---|---|
| Buy to open | Purchase an option to establish a new long position | Creates a new long position |
| Sell to open | Sell (write) an option to establish a new short position | Creates a new short position |
| Sell to close | Sell a previously purchased option to close the long position | Eliminates an existing long position |
| Buy to close | Buy back a previously written option to close the short position | Eliminates an existing short position |
Key distinctions:
- Opening transactions create new positions and increase open interest
- Closing transactions eliminate existing positions and decrease open interest
- An investor can close a position at any time before expiration by executing the opposite transaction
- Closing in the secondary market (selling to close or buying to close) is the most common way to exit an options position; most options are not exercised
Exam Tip: Gotchas
- "Sell to open" creates a new short position; "sell to close" eliminates an existing long position.
- Most options are closed via offsetting transactions, not exercised.
What Are the Three Ways an Option Position Ends?
Every option position must eventually end in one of three ways:
| Method | Who Initiates | Result |
|---|---|---|
| Closing transaction | Either buyer or seller | Position offset in the market; most common exit |
| Exercise / Assignment | Holder exercises; OCC assigns to writer | Physical delivery of stock (equity options) or cash settlement (index options) |
| Expiration | Automatic (no action needed) | Option expires worthless; holder loses full premium; writer keeps full premium |
- Closing transaction: The holder sells the option, or the writer buys it back. The position is eliminated.
- Exercise: The holder normally chooses to exercise the right, and the OCC then assigns a writer. On expiration day, the OCC's Exercise-by-Exception procedure automatically exercises expiring standardized equity options that are in the money by a specified amount unless the holder files a timely Contrary Exercise Advice saying otherwise. For equity options, actual shares change hands.
- Expiration: If the option is out of the money at expiration, it expires worthless with no action required. The holder loses the premium paid; the writer retains the premium collected.
Remember: Exercise is normally the holder's choice, subject to the Exercise-by-Exception procedure at expiration. The writer can only be assigned (involuntarily) or can buy to close before that happens.
Exam Tip: Gotchas
- The writer can avoid assignment by buying to close before the holder exercises. Assignment is not inevitable.
- Exercise is normally the holder's choice; the writer has no say in when (or whether) assignment happens. The exception is expiration day, when Exercise-by-Exception can trigger automatic exercise absent a timely Contrary Exercise Advice.
What Should You Check on Exam Day?
- Opening transactions increase open interest; closing transactions decrease it
- "Sell to open" starts a new short position; "sell to close" ends an existing long position
- Most positions exit through a closing transaction, not exercise
- Exercise is the holder's choice; the writer can only be assigned or buy to close first