If you’re new to trading options or even if you are experienced, executing an option order can be a bit confusing if you don’t know exactly what order to execute.
When trading options (calls or puts) you really only have two choices when placing an order; you can either open a position or close a position. For now we will discuss how you can open a trade.
If you are curious about closing a trade you can read more about it here.
After selecting which security you wish to trade and it’s corresponding option, you are presented with two ways in which to open that trade: ‘Sell to open’ or ‘Buy to open’.
You want to select buy to open when you are going long on an option. When going long on either a call or put option you don’t need any stock or funds to back up the position. You are buying the option to open the position. This is the order entry that many people are used to and start out with when first investing with or trading options.
If you sell to open a position you are basically selling short or ‘writing’ an option to open the trade. To sell an option to establish a position you need either the corresponding stock shares or their cash equivalent as collateral for the position.
If you don’t have the stock to back up your ‘sell to open’ order you are shorting the option or selling a ‘naked position’. If you have the shares to back up the ‘sell to open’ trade then you are selling a ‘covered position’. This is the basis of our strategy focus here, writing covered calls. We use the ‘sell to open’ order when selling covered calls.
Make sure to choose your type of entry order wisely. With one mistaken click of the mouse you could lose a great deal of money, simply by not knowing which order type to use.
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