A European put option allows the holder to exercise the put option for a short period of time right before expiration, while an American put option allows exercise at any time before expiration. The put buyer either believes that the underlying asset's price will fall by the exercise date or hopes to protect a long position in it. The advantage of buying a put over short selling the asset is that the option owner's risk of loss is limited to the premium paid for it, whereas the asset short seller's risk of loss is unlimited its price can rise greatly, in fact, in theory it can rise infinitely, and such a rise is the short seller's loss.
The put writer believes that the underlying security's price will rise, not fall. The writer sells the put to collect the premium. The put writer's total potential loss is limited to the put's strike price less the spot and premium already received. Puts can be used also to limit the writer's portfolio risk and may be part of an option spread. That is, the buyer wants the value of the put option to increase by a decline in the price of the underlying asset below the strike price.
The writer seller of a put is long on the underlying asset and short on the put option itself. That is, the seller wants the option to become worthless by an increase in the price of the underlying asset above the strike price.
Generally, a put option that is purchased is referred to as a long put and a put option that is sold is referred to as a short put. A naked put , also called an uncovered put , is a put option whose writer the seller does not have a position in the underlying stock or other instrument.
This strategy is best used by investors who want to accumulate a position in the underlying stock, but only if the price is low enough. If the buyer fails to exercise the options, then the writer keeps the option premium as a "gift" for playing the game. If the underlying stock's market price is below the option's strike price when expiration arrives, the option owner buyer can exercise the put option, forcing the writer to buy the underlying stock at the strike price. That allows the exerciser buyer to profit from the difference between the stock's market price and the option's strike price.
But if the stock's market price is above the option's strike price at the end of expiration day, the option expires worthless, and the owner's loss is limited to the premium fee paid for it the writer's profit. The seller's potential loss on a naked put can be substantial. If the stock falls all the way to zero bankruptcy , his loss is equal to the strike price at which he must buy the stock to cover the option minus the premium received.
The potential upside is the premium received when selling the option: During the option's lifetime, if the stock moves lower, the option's premium may increase depending on how far the stock falls and how much time passes. If it does, it becomes more costly to close the position repurchase the put, sold earlier , resulting in a loss.
If the stock price completely collapses before the put position is closed, the put writer potentially can face catastrophic loss. In order to protect the put buyer from default, the put writer is required to post margin. The put buyer does not need to post margin because the buyer would not exercise the option if it had a negative payoff.
A buyer thinks the price of a stock will decrease. He pays a premium which he will never get back, unless it is sold before it expires. The buyer has the right to sell the stock at the strike price. The writer receives a premium from the buyer. If the buyer exercises his option, the writer will buy the stock at the strike price. If the buyer does not exercise his option, the writer's profit is the premium. A put option is said to have intrinsic value when the underlying instrument has a spot price S below the option's strike price K.
Once you have a decent knowledge of those topics it makes it much easier to understand the different orders used to buy and sell options. There is quite a range of different options order that options traders can use and this in itself is a fairly complicated subject.
However, providing you can understand the four main types of options orders, of which the sell to close order is one, then you are in a position to start trading options. The sell to close order is one of the two most simple and commonly used options orders along with the buy to open order. Basically the buy to open order is used to enter a position by buying options contracts, and the sell to close order is used to exit that position by selling those options contracts. The other two main options are essentially a reversal of that process; the sell to open order is used to enter a position by short selling options contracts and that position can be closed by using the buy to close order.
You do need to understand the distinction between these four types of options order, but in practice using the sell to close order is actually a relatively straightforward process. In very simple terms, there are two ways to make money in options trading: In practice, most options traders tend not to exercise their options and instead try to make their returns through the buying and selling of options contracts.
There are a number of different options trading strategies that can be used, but the most basic strategy is to simply make a profit by buying options contract and then selling them when they go up in value.
When you buy stocks you are relying on them going up in value in order to make a profit by selling them; you can also receive dividends on stocks to make a profit. One of the big advantages of options trading is that you can also buy options contracts that make you money when the relevant stock goes down in value. This is because there are two main types of options contracts that you can buy, call options and put options. Call options increase in value when the price of the underlying stock goes up, whereas put options increase in value when the price of the underlying stock goes down.
Of course, the underlying security in options contracts can also be other financial instruments other than stock. As mentioned above, it's possible to make money through buying options contracts and then exercising your option under the right circumstances.
However, it really is somewhat easier to buy options contracts and simply sell them if they go up in valuenwhich is where the sell to close order is used. If you own call options on a particular stock, then you have the right to purchase that stock at an agreed strike price. If the current trading price of that stock is higher than the strike price in your options contracts, then you can exercise your option to buy that stock at the strike price and then sell the stock immediately for a profit.
However, assuming you bought the options contracts before the price of the stock went above the strike price, you could simply place a sell to close order to sell those options contracts and make a similar profit without having to worry about actually buying and selling the stock.