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What is a Closing Purchase?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 19 November 2016
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    2003-2016
    Conjecture Corporation
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Closing purchases are transactions in which the investor will change his or her written position by purchasing an option with terms that are like those of a recently sold option. The main benefit to this type of action is that the investor can reduce or possibly even eliminate a short position associated with the options involved. This action will tend to have a positive effect on the value of the investment portfolio, and provide the investor with the opportunity to work with an option that carries a longer position.

In order to effect a closing purchase, the seller will work with a broker to manage the proper sequence in the combination. Together, the broker and the investor will evaluate the current short positions that are part of the portfolio. An option with a short position will be selected for sale. The broker will then manage the sale of the selected option. At the same time, the broker will identify a purchase of the same option with a longer position, and make arrangements to execute an order to purchase.

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Once the option with the short position is sold, the investor has fulfilled his or her obligation as a writer for that option. This leaves the investor free to purchase the similar option and enjoy the longer position associated with the new purchase. As a result of this two step closing purchase, the investor is able to continue enjoying the benefits of owning the option, since the close date is now no longer pending in the short term.

While the actual process is very simple, both the investor and the broker often have to put a great deal of thought into creating a closing purchase strategy. Selecting the right option for the method is important, since the idea is to continue enjoying a good return on the purchased option. If the option begins to decrease in value after a longer position is purchased, the closing purchase will not create the desired result.

A close out approach of this type is a common investment tool. Close outs by their very nature make it possible for an investor to minimize losses while simultaneously making it possible to maximize return. Few transaction types can accomplish this with the ease of a closing purchase.

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