Financial Industry Regulatory Authority (FINRA) Practice Exam

What term describes the situation when an investor sells an option that they previously purchased?

1. Selling to close

2. Selling to open

3. Short selling

4. Liquidating a position

The correct answer is: Selling to close

The term that best describes the situation when an investor sells an option that they previously purchased is known as "selling to close." This process occurs when an investor who holds a long option position decides to sell that option in order to exit the position, ideally at a profit or to limit a loss. In this context, the investor's original transaction involved buying the option, which established a long position. The act of selling this option subsequently allows the investor to close out that position. This terminology is essential in the options market, as it differentiates between opening and closing transactions tied to existing positions. The other terms provided have specific meanings that do not apply in this situation. "Selling to open" refers to a new transaction where an investor sells an option they do not own, which establishes a new short position. "Short selling" relates to the sale of securities that the seller does not own, expecting to buy them back at a lower price, but it is not specific to options nor does it apply to the act of selling a previously purchased option. "Liquidating a position" generally refers to the process of selling any security to turn it into cash, but it is broader and does not specifically emphasize the distinction of option transactions as "selling to close