SIE (Securities Industry Essentials) Practice Exam

A transaction in which a writer covers a position by purchasing an option is called:

1. A closing sale

2. A closing purchase

3. An opening sale

4. An opening purchase

The correct answer is: A closing purchase

In the context of options trading, when a writer (or seller) of an option takes action to eliminate their obligation or manage their risk, this is referred to as a closing purchase. A closing purchase occurs when the writer buys back the same option that they initially sold, effectively closing out their position in that option. This is important for risk management, as it allows the writer to limit potential losses from adverse market movements. By purchasing the option back, the writer is removing their obligation to fulfill the terms of the option contract if exercised by the holder. In contrast, the other concepts relate to different actions in options trading. A closing sale would refer to selling an option that one previously owned to close out that position. An opening sale refers to the initial transaction in which an option is sold to establish a new position. An opening purchase is the initial buying of an option to establish a new position. Understanding these terms helps clarify the mechanics of options trading and the various strategies employed by traders.