Closing an option contract can be a daunting task, especially if you are new to trading options. An option contract is a financial agreement between two parties that gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a predetermined price on or before a set date. To close an option contract, you must take the opposite position of the original trade. Here are the steps you need to follow to close an option contract.
Step 1: Determine the Type of Contract You Have
There are two types of option contracts: call options and put options. A call option gives the holder the right to buy an underlying asset, while a put option gives the holder the right to sell an underlying asset. You must determine which type of contract you hold before moving on to the next steps.
Step 2: Calculate the Profit or Loss
Before closing an option contract, you need to calculate the profit or loss from the trade. This is important as it helps you determine whether you want to close the contract or hold on to it. To calculate the profit or loss, you need to take into account the premium paid or received, the strike price, and the current price of the underlying asset.
Step 3: Review Your Trading Plan
If you have a trading plan in place, review it before closing the option contract. Your trading plan should outline the conditions under which you will exit a trade. Stick to your trading plan and avoid making impulsive decisions.
Step 4: Place a Closing Order
To close an option contract, you must place a closing order with your broker. This involves taking the opposite position of the original trade. For example, if you bought a call option, you must sell a call option to close the position. Likewise, if you sold a put option, you must buy a put option to close the position.
Step 5: Monitor Your Trade
Once you have placed a closing order, monitor your trade closely. Keep an eye on the market conditions and the price movements of the underlying asset. If you notice any significant changes, you may want to adjust your trade or close the position early.
In conclusion, closing an option contract can be a complex process. However, by following these steps and having a clear trading plan in place, you can successfully close your trades and manage your risk effectively. As always, it is recommended that you consult with a financial advisor or professional before engaging in any trading activity.