Buy to Open

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21 Aug, 2024

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Buy To Open (BTO) Meaning

A buy-to-open order is an options contract that transfers ownership of the contract to the investor. A buy-to-open order is placed at the beginning of the trade and predicts a hike in asset price. It is the opposite of the sell-to-open strategy. A buy-to-open order aims to open a new options contract or initiate a new long position in the market.

Investors who want to start a new options contract can use the buy-to-open option instead of purchasing an existing options contract. In contrast, traders place a buy-to-close to end an existing options contract. Here, the trader bets on the options price falling over time.

Buy to Open (BTO) Meaning

A buy-to-open (BTO) order is an options contract; investors acquire better control over the contract. This provision is used for opening option positions. It is the opposite of sell to open strategy.
In a BTO contract, the investor takes a long position on the underlying instrument—they can exercise the contract if the asset price surpasses the strike price.
The BTO option is used to hedge portfolio risks.
In a way, the BTO option can be considered a 'bet.' This is because the parties are betting on the underlying asset's price movement.

Buy To Open (BTO) Explained

In a buy-to-open option, the investor takes a long position on an underlying asset. If the asset price rises to the strike price, the investor exercises the contract. It is essential to understand that a "buy to open" order may contain a call option (for buying the underlying asset) or a put option (for selling the asset).

Before venturing further, let us quickly define options. Options are financial contracts that allow the buyer a right to buy or sell an asset on a specific date at a particular price, called the strike price. The strike price is predetermined during purchase or sale. An option is a type of financial derivative. It represents a contract sold by one party to another party.

An options contract consists of the following two parties—a holder, the buyer of the contract—and a writer, the seller of the contract. Options derive their value from an underlying asset. For example, the underlying asset could be a stock, bond, index, foreign currency, commodity, or basket option.

It is important to note that the options contract gives the buyer the right, but it is not an obligation. Simply put, buyers exercise the contract only if they benefit from it; if the contract can lead to losses, the buyer will not undertake the transaction. Investors opt for an options contract because it allows them to forecast asset price fluctuation without acquiring real ownership.

Investors who want to take a long position on an option contract place a buy-to-open order. Here, investors expect the option price to rise over time. For example, when an investor buys a call option, the underlying security price must rise above the break-even point. Only then can the trade book a profit.

When an investor uses a put option, the price of the underlying securities must decrease significantly to bring the price of the put option below the break-even point.

Example

Let us look at buy-to-open examples to understand the concept better.

Jarrod is an investor. He conducts market research and expects the price of ABC Ltd stocks to rise from $100 to $200 within three months. Thus, Jarrod places a BTO order on a call option for Stock ABC Ltd. He places the order at a strike price of $150 and an expiration period of more than three months.

If the price rises to $200 per share, Jarrod will exercise his right to purchase ABC Ltd. Stocks (at $150 per share). Then, consecutively, he will sell the stocks at a higher price.

It is important to note that this hike in price must occur within the period mentioned in the options agreement.

Buy To Open vs Buy To Close vs Sell To Open

Let us look at buy-to-open vs. buy-to-close vs. sell-to-open comparisons to distinguish between them:

Basis	Buy to open	Buy to close	Sell to open
Meaning	Buying to open implies purchasing an option to open a position.	The buy-to-close option is used to close out short-option positions.	Selling to open is when an investor sells an option contract and opens a new position.
Premium	The profit is unlimited.	Profit is capped to the amount of the premium received.	The premium is collected at the time of the trade.
Losses	Losses are limited to the amount of premium paid.	Losses are limited to the amount of premium paid.	Profits are limited if the underlying asset is sold off too early.

Frequently Asked Questions (FAQs)

When do investors purchase a buy-to-open contract?

Different kinds of options contracts can be purchased using a BTO order. However, call options and put options are more common. A call option grants the right to buy the underlying asset, while a put option grants the right to sell the underlying security. Therefore, whether investors believe the underlying security's value will increase or decrease, a trader can purchase options contracts using the BTO order.

What is buy to open and buy to close?

A trader can open a long call or long put position using the buy-to-open option. For example, if a trader assumes a buy-to-open position on a put option, they expect the underlying asset's price to decline. On the other hand, a buy-to-close option is bought by a trader who wants to close an open position.

What is a buy-to-open call option?

If a trader opens a BTO position on a call option, it signifies that the investor is purchasing the right to buy the underlying asset at the strike price. Here, the investor anticipates a rise in the underlying asset price. Every option speculates between a buyer and a seller about asset price movement. An options contract is a derivative contract as it does not have a direct relationship to the underlying asset.