What is an option to sell?

Answer 1

An option to sell, sometimes referred to as a "put" option, gives the owner of the option the right to sell "something" to a designated buyer at an agreed price on an agreed date, or within a specified date range. The "something" can be one of a wide range of tangible or intangible assets. For example it could be oil, gold, shares in a company, wine, wheat, currencies, or even a stock market index such as the S & P 500 or the FTSE100. The list is endless. A US farmer, preparing for his corn harvest in the coming season, can "lock in" the value of his crop by taking out an option to sell an agreed amount at an agreed price. This way, he gets certainty of income and predictability as to price. Of course, if the market price on the day he sells his crop has risen to a value higher than his option price, then he will forego some income. But if the market price is below his option price, then he will receive a higher price than he would in the open market. In more sophisticated trading, such as strategies employed by some hedge funds, one does not need to own the underlying asset to purchase an option to sell. For example, a trader might purchase an option to sell stock in company X in 6 month's time at a stock price of $50. He does not need to own the stock now. If he believes that the stock price in 6 months will be $40, and the option costs $5 per share, then he will pay $5 per option now; buy the shares for $40 and immediately sell them for $50 in six month's time; and make a net profit of $5 on a $5 investment over six months. Of course, if the stock has risen to $60 when the option is exercised then he will be $15 out of pocket.