Opening and Closing Transactions
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 options questions on the exam.
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. The exam tests whether you know the difference.
- Most options are closed via offsetting transactions, not exercised.
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 chooses to exercise the right. The OCC then assigns a writer. 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 always the holder's choice. 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 always the holder's choice. The writer has no say in when (or whether) assignment happens.