What it means
Brokers ask for an order type because an option can be opened or closed, bought or sold. That gives four combinations: buy to open, sell to open, buy to close and sell to close.
Sell to close is the one that ends a long position started with a buy to open order. The trader owns the contract at the start, and a long call or long put has three exits: exercise it, let it expire, or sell it, with selling being the sell to close order.
Most retail option positions end by selling rather than exercising, because an option that is sold keeps its time value while exercising throws it away. At expiration time value is zero, so the difference only matters before then.
Investopedia says the order works in the money, at the money or out of the money. Traders usually sell to close a call when they no longer want a bullish position, and a put when they no longer want a bearish one.
The same wording appears, less often, in stock and bond trading for a sale that ends a long position. The order is easy to confuse with sell to open.
Sell to open creates a short position and brings a premium in, with an obligation attached. Sell to close only removes what the trader already holds.
The SEC's investor bulletin on options explains the basic contract terms, and in many markets one equity option covers 100 shares, though contract sizes differ so the specifications should be checked. A limit order is common for the exit, because a market order sells at the best bid and thin options can have wide spreads.
A limit price protects the trader from a poor fill but may not execute.
In practice
Real-world examples.
Example
A fictional trader buys a $170 strike call for $7.50 when the stock is $175. By expiration the stock is $180, so the call is worth $10.00 ($180 - $170). Selling to close gives a profit of $2.50 per share, or $250 for a 100-share contract before fees.
Example
The same call is held while the stock rises only to $177.50. The call is worth $7.50, the same as the purchase price. Selling to close at $7.50 gives zero profit before fees, so a $1.00 round-trip commission would make it a small loss.
Example
The stock rises only to $176.00, so the call is worth $6.00 at expiration. Selling to close at $6.00 locks in a loss of $1.50 per share, or $150 per contract. It also lets the trader take the remaining $600 of value without needing $17,000 to buy the 100 shares at the strike.
Formula
Calculation
Profit per share = Sale price - Purchase price. With $10.00 - $7.50 = $2.50.
Total profit = (Sale price - Purchase price) x Number of contracts x Contract size - Fees. With $2.50 x 1 x 100 = $250 before fees.
Intrinsic value of a call = Stock price - Strike price, if positive. With $180 - $170 = $10.00.Case study
Seen in the real world.
This case study is fictional and illustrative. Priya, 34, in Mumbai, buys one call option for $750 on a 100-share contract because she expects a stock to rise. Two months later the stock is up, and the call is quoted at $1,000. She sells to close with a limit order instead of waiting for expiration. She enters the order as a sale of the contract she already owns and checks the confirmation screen.
The order fills at $1,000, a gain of $250 before $20 in fees, or $230 after fees. She no longer owns the contract, so later stock moves cannot hurt or help her on that position. A friend says she could have made more by waiting. She notes that the stock could also have fallen, and that time decay was working against her each day. Her plan was to take a modest gain, and she followed it.
Watch out
Common mistakes.
- Choosing sell to open when the intent was to close, which creates a new short position instead of ending the old one.
- Using a market order on a thinly traded option and accepting a poor price.
- Forgetting that selling to close ends the position, so later gains are no longer earned.
Questions
People also ask.
What does sell to close mean?
It is an order that sells an option the trader already owns, which ends a long position.
How is sell to close different from sell to open?
Sell to open creates a new short position, while sell to close ends a long one. The first brings an obligation, and the second does not.
Does a sell to close always make money?
No. The result depends on the sale price compared with the purchase price, plus fees. It can be a profit, a break-even or a loss.
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