Buy to Open Definition, Explained in Detail with Example
The term Buy to open is a definition used in everyday trading concepts predominantly by brokerages. Yet, it’s also a definition that anybody dealing in the trading or financial industry would do well to understand. This is especially so when it comes to making those crucial decisions on the trading markets, or when dealing with creating types of financial transactions.
There are four types of options that are commonly used in the industry. Alongside buy to open, these include buy to close, sell to open and sell to close.
Here we look at precisely what the basic definition of buy to open means, alongside offering an example of it at work. By analyzing the term further, we can provide a better understanding.
This way, you can approach your position with ease, aware of how Buy to open effects any financial decisions hereon.
Why Is Buy to Open an Important Definition?
It’s important to gain a better understanding of what the term buy to open means. This is primarily because it will help you to place the right order for your individual circumstances.
Getting an order wrong can indeed prove costly. This is because it’s guaranteed to lead to losses. Thus, learning more about the buy to open option will help you with your financial trading activities.
But, when you do begin, you may find that the options available in trading are somewhat confusing. However, it’s worth noting here that out of all the four orders, the buy to order is the most common. Therefore it tends to be easier to understand and apply to your current financial situation.
What Is Meant by Buy to Open?
Buy to open signals an order that is used to purchase options. It can be selected when opening a new position. It is, in many ways similar to the process of buying stocks, or indeed other financial instruments.
Overall, a buy to open order is a signal that you actually own the options contract. Thus, you can sell them if you want to. Or, you can make a decision to exercise your options.
There are then, two common reasons why you would select a buy to open order:
- You believe that the options contract is likely to increase in value over time. Thus, it will eventually allow you to sell it for a profit.
- You want to exercise your rights for the appropriate options.
Looking at it in a little more depth, when buying an option, you pay the premium. This allows you to initiate the trade. It also means you obtain the options rights.
How you benefit is from the underlying equity moving. This means beyond your strike price and that of the options premium you initially paid. In financial terms, this is referred to as a process of purchasing volatility. This is because you initially believe it to be under-priced.
When considering buy to open in its simplest of terms, it is like regular stock trading. Thus, you open a position by purchasing stock and close the position by selling it.
What Do I Need to Know About Buy to Open?
The buy to option definition is a little different than many expect. Nowhere is this clearer than in its terminology, indication/initiation, and its probability of being denied.
- Something worth noting early on is the buy to open terminology. This relates to how different it is to that used in stock trading. That is, stock trading terminology tends to be more straightforward!
One significant example of this is the use of the term buy. In trading, you would simply place a buy for your stock. However, options traders have to place a buy to open.
- Market participants can take specific cues from a buy to open position. These tend to include believing the trader knows something about the order. Or, assuming the trader has an ax to grind about something! These cues are more common the more substantial the order.
Yet, this doesn’t have to be the case either! Many options traders participate in hedging or spreading activities. These then indicate that the buy to open is actually offsetting existing positions.
- Certain market conditions can see a buy to open order being denied. An excellent example of this is when a stock with options is halted or delisted. Thus, it’s declared by the exchange that only closing orders are to be initiated. Therefore the buy to open order is refused.
Who Can Place Buy to Open Orders?
Now you know a little more about what buy to open orders are, you may be thinking of participating in such activities. However, these types of orders require the services of a stockbroker.
Unfortunately, options contracts on the exchanges can’t be bought by members of the public. This is where a stockbroker takes on the purchasing role.
Most stockbrokers will be able to help you buy and indeed sell options contracts. Thus, you can place a buy to open order with any stockbroker offering this service.
Many people interested in doing this will use an options broker online. This allows you to create an account and then log in to place your order as and when you want to do so. Best of all, the online process for buy to open orders is considered to be the simplest of transactions to perform.
An Example of The Buy to Open Definition at Work
Fortunately, the buy to open definition is easy to offer an example of.
Let’s say that Mia has undertaken an analysis of the stock belonging to a company called ABC.
Through her investigations, she believes there’s a strong possibility that ABC’s stock prices will go up in the following months.
Therefore, she uses this information to purchase call options for several stocks. Mia, thus, does this utilizing placing a buy to open order.
Closing a Buy to Open Order
When a buy to open order needs closing, what follows is the use of a buy to close order.
In brief, this is linked to a buy to open order as it is used to purchase an options contract. However, what the buy to close term does is close a previously opened position – that is, rather than opening up a new one.
Therefore, it makes sense that once you’ve made a buy to open order, you will at some point be needing to think about a buy to close request.
For ease of use, a buy to close order has one purpose; to close out an option position!
Once again, your stockbroker will know when to execute a buy to close order. So, you can get the best profit possible meanwhile from your buy to open option.
Final Words on the Buy to Open Process
Hopefully, we have proven the simplicity of the buy to open definition!
Buy to open is very different from the process of buying stock itself or say bonds or other commodities. However, these orders are the most flexible and allow you to speculate on the values of options contracts.
Therefore, you can simply select an online broker and begin placing your buy to open orders accordingly. Meanwhile, you’ll now have full knowledge of how they can best work to your financial advantage.