How to Close Out a Long or Short Call Option

Closing out a call option involves exiting an existing position prior to its expiration date. This action allows an investor to realize profits, cut losses, or manage market exposure without holding the contract until maturity. Both long call options, where an investor holds the right to buy an underlying asset, and short call options, where an investor holds the obligation to sell, can be closed out through specific procedural steps.

Closing Out a Long Call Option

An investor holding a long call option has the right to purchase the underlying asset at a predetermined price, known as the strike price, before the option’s expiration. The most common method to close this position is by selling the contract back into the market. This “sell to close” order is placed through a brokerage platform.

When initiating a “sell to close” order, investors typically choose between a market order or a limit order. A market order aims for immediate execution at the best available current price, prioritizing speed. Conversely, a limit order specifies a minimum price at which the investor is willing to sell, ensuring a desired profit or loss threshold is met. However, it carries the risk of the order not being filled if the market price does not reach the specified level. This transaction results in either a profit or loss, calculated as the difference between the selling price and the initial purchase price of the option, minus any transaction costs.

Alternatively, if the long call option is “in-the-money,” meaning the underlying asset’s price is above the strike price, the holder may choose to exercise the option. Exercising grants the right to buy 100 shares of the underlying stock per contract at the strike price. To exercise, the investor must notify their brokerage firm and ensure sufficient funds are available to purchase the shares.

A less active way a long call position can conclude is by allowing it to expire. If the option is “out-of-the-money” at expiration, meaning the underlying asset’s price is below the strike price, the option will expire worthless. In such a scenario, the investor incurs a loss equal to the premium originally paid for the option contract.

Closing Out a Short Call Option

An investor who has sold, or “written,” a call option holds an obligation to sell the underlying asset at the strike price if the option is exercised by the buyer. The primary method to exit this position is by “buying to close” the option. This involves purchasing an identical option contract in the market to offset the existing short position, thereby eliminating the obligation.

The process of buying to close requires the investor to place an order through their brokerage platform. As with long positions, market orders can be used for immediate execution, while limit orders provide control over the price paid to close the position. Executing a “buy to close” order effectively cancels the original obligation, and any difference between the premium initially received and the cost to buy back the option determines the profit or loss. This action helps manage risk, particularly for uncovered short calls, which can carry substantial liabilities.

If a short call option is not bought back and expires “in-the-money,” the option writer may face “assignment.” Assignment obligates the writer to sell 100 shares of the underlying stock per contract at the strike price. This means the investor must deliver the shares, even if it requires purchasing them at the current, potentially higher, market price, or utilizing shares already held. Assignment can occur at any time before expiration and is a direct consequence of the long option holder exercising their right.

Key Factors When Closing an Option

When closing any option position, several financial and practical considerations warrant attention. Transaction costs directly impact the net profit or loss of a trade. These typically include brokerage commissions, which can vary, and other exchange and regulatory fees.

Tax implications are another significant factor. The Internal Revenue Service (IRS) distinguishes between short-term and long-term capital gains or losses based on the holding period. If an option is held for one year or less, gains are short-term and taxed at an individual’s ordinary income tax rate. If held for more than one year, gains are long-term and qualify for preferential tax rates. These transactions are reported on IRS Form 8949 and Schedule D.

Market liquidity also plays a role in the ease and efficiency of closing an option position. Liquidity refers to how readily an option contract can be bought or sold without significantly affecting its price. Key indicators include trading volume and open interest. Options with high liquidity generally have narrower bid-ask spreads, which is the difference between the highest price a buyer is willing to pay and the lowest price a seller is willing to accept. A wide bid-ask spread, common in less liquid options, can result in higher implicit transaction costs and make it more challenging to execute trades at a desired price.