CG55525 | Traded options: LIFFE: purchaser of option: closing sales

It is not necessary for the purchaser of an equity option to realise profit through exercising the option. It is also possible to take profit by making a closing sale. This involves selling an option identical to the one they hold and has the effect of extinguishing their rights as option holder. An option holder may also make a closing sale to stop further losses.

The purchaser of an option can never make a loss greater than the premium they have paid. By making a closing sale they will limit the loss (or crystallise the profit) to the difference between the amount paid for the option and the premium received on making the closing sale.

Example

Continuing the example in CG55520, Mr Smith has 10 January 260p call contracts over XYZ PLC shares which cost £2,400. The market price of XYZ PLC shares rises to 300p and the premium on a January 260p call option rises to 50p per share. Mr Smith sells 10 contracts receiving proceeds of 10 x 1,000 x 50p = £5,000 (less dealing costs). He makes a profit of £2,600.

If the price of the shares had fallen the premium may have fallen to 1Op a share. If Mr Smith makes a closing sale he would receive proceeds of 10 x 1,000 x 1Op = £1,000. He makes a loss of £1,400.

For the tax treatment of transactions in traded options see CG55536.