There are a few reasons to close an options contract before it expires and they include:
Reason 1: To secure your profits
Say you sold a PUT contract and on the next day, the share price spikes up. You are now able to close the contract by paying a lower price than the premium you received one day earlier. The net difference is your profits. And you have no obligation to buy any shares as the contract is no longer valid anymore.
Reason 2: To cut your losses
If you sold a PUT option contract and the share price keeps plunging, you may want to cut your losses by closing the contract earlier than to let it expire and get exercised. The share price could be on a downtrend and you will be forced to own 100 shares at the strike price, which is much higher than the current market price.
Reason 3: To free up capital
The share price could have stayed sideways for a while after you sold a PUT contract and because you have better investment opportunities elsewhere, you can close your contract and free up capital that has been set aside as collateral for your cash-secured PUT.
Reason 4: To prevent losing your shares
Suppose you are selling covered CALL on your shares to earn a monthly sideline income and you wish to hold these shares for the long term. However, nearing the expiration date, the share price starts to rally and rises higher than your strike price. You risk losing your shares if it stays that way upon expiration. So, in order not to lose your shares, you can close the contract earlier.
How To Close An Options Contract?
Closing an option contract is basically as simple as how you open an options contract. If you have sold an options contract, you close by buying it back at the same strike price and expiration date. If you have bought an options contract, you close the contract by selling the options contract at the same strike price and expiration date.
To summarise, to close an options contract, you will turn from buyer to seller or vice-versa, all else remains the same, including strike price, expiration date and the type of contract, whether it is CALL or PUT contract.
Example: You sold a PUT contract on Apple at a strike price of $170, and the expiration date is 31 Dec 2021. You collected a premium of $1000. When Apple’s share price spikes up, you decide to lock in the profit and close the contract by buying a PUT option contract on Apple shares, with the same strike price of $170 and an expiration date of 31 Dec 2021. You pay a premium of $200. The net difference of $800 ($1000 – $200) is your profit to keep with no contract obligation as the contract has been closed.