What Is Sell to Close?
Sell to close indicates that an options order is being placed to exit a trade. The trader already owns the options contract and by selling the contract will close the position.
Sell to close is used to end a long position started with a buy to open order. It is similar to buy to close and sell to open orders. It’s also used in equity and fixed-income trading to show a sale that ends a long position, although less frequently.
Key Takeaways
- “Sell to close” is an order used to exit a long position in options trading.
- It is often employed after a “buy to open” order to finalize a trade.
- Options can be sold to close whether they are in the money, out of the money, or at the money.
- Traders use sell to close to either secure profits, break-even, or minimize losses.
- Selling to close long call options is common when a trader wants to end their bullish stance on an asset.
How “Sell to Close” Functions in Options Trading
Sell to close means ending a position by selling the contract. In options trading, contracts are bought to create both short and long positions. Once a trader owns a contract, they have three options:
- The option is out of the money (OTM) and expires worthless;
- The option is in the money (ITM) and can be exercised to trade for the underlying or settle for the difference; or
- The option can be sold to close the position. A sell to close order may be made with the option ITM, OTM, or even at the money (ATM).
Traders will typically sell to close call options contracts they own when they no longer want to hold a long bullish position on the underlying asset. They sell to close put options contracts they own when they no longer want to hold a long bearish position on the underlying asset.
Real-World Example of Executing a “Sell to Close” Order
Let’s assume a trader is long an exchange-traded option using a buy to open order on a call option on Company A. Imagine that, at the time, the stock was priced at $175.00. Let’s also assume that the $170.00 strike call, with an expiration date 90 days away, was selling for $7.50 per share. This gives the option $5.00 of intrinsic value ($175.00 stock price – $170.00 strike price = $5.00 intrinsic value) and $2.50 of extrinsic value ($7.50 option premium – $5.00 intrinsic value = $2.50 extrinsic value).
As time goes by and the value of Company A fluctuates up and down, the value of the call option is going to fluctuate as well. The higher the value of the call option goes, the more profitable it will become. Conversely, the lower the value of the call option goes, the less profitable it will become. However, those profits, or losses, will only be realized once the trader exits the position using a sell to close order.
A trader can face three outcomes when selling to close a long option.
How to Profit from a “Sell to Close” Order
If the price of the underlying asset increases more than enough to offset the time decay the option will experience (the closer it gets to expiration) then the value of the call option will also increase. In this case, a trader can sell to close the long call option for a profit.
Let’s assume in this scenario that Company A rises from $175.00 to $180.00 by expiration, increasing the value of the call option from $7.50 to $10.00. This option is now comprised of $10.00 of intrinsic value ($180.00 stock price – $170.00 strike price = $10.00 intrinsic value) and $0.00 of extrinsic value (options have no extrinsic value at expiration). The trader can now sell to close the long call option position for a profit of $2.50 ($10.00 current value – $7.50 purchase price = $2.50 profit).
Selling to Close at Break-Even: What You Need to Know
If the price of the underlying asset increases only enough to offset the time decay the option will experience then the value of the call option will remain unchanged. In this case, a trader can sell to close the long call option at break-even.
Let’s assume in this scenario that Company A rises from $175.00 to $177.50 by expiration, keeping the value of the call option at $7.50. This value is comprised of $7.50 of intrinsic value ($177.50 stock price – $170.00 strike price = $7.50 intrinsic value) and $0.00 of extrinsic value. The trader can now sell to close the long call option position at break-even ($7.50 current value – $7.50 purchase price = $0.00 profit).
Managing Losses with a “Sell to Close” Order
If the price of the underlying asset does not increase enough to offset the time decay the option will experience, then the value of the call option will decline. In this case, a trader can sell to close the long call option at a loss.
Let’s assume in this scenario that Company A only rises from $175.00 to $176.00 by expiration, dropping the value of the call option to $6.00. This value is comprised of $6.00 of intrinsic value ($176.00 stock price – $170.00 strike price = $6.00 intrinsic value) and $0.00 of extrinsic value. The trader can now only sell to close the long call option position at a loss of $1.50 ($6.00 current value – $7.50 purchase price = $1.50 loss).