What is a sell option?

  An option is a security that gives the right, but not the obligation, to buy or sell an asset at a pre-agreed price during the term of the document. There are options for selling and buying an asset. Despite the fact that they differ insignificantly from each other, the ways they are applied are completely different.

 

What is a sell option?

  Such a document gives its holder the right to sell the underlying asset. The strike price is agreed in advance and does not change throughout the entire term of the contract regardless of the state of the financial market.
  The seller of the security is obliged to fulfill this right, that is, to purchase the agreed asset from the buyer or compensate the amount of profit that the buyer could have received from the act of purchase and sale. In the options market, such securities are more commonly called put options.

  The seller assumes a certain risk, since they may incur significant losses if the asset price changes against them. Brokers take such a step only because of the premium paid at the moment the transaction is concluded. The option premium is equivalent to the risk assumed by the seller and on average ranges from 6 to 9%. In some cases, the premium size may be significantly increased, for example, if the strike price of the underlying asset does not correspond to the real market situation.

 

Types of sell options

  Depending on the type of underlying asset, all options can be divided into exchange-traded, currency, and commodity.

 

Exchange-traded sell options

  This name does not at all mean that such contracts circulate only on global exchanges. In fact, the participants in the transaction may not even be related to professional markets. The point is that the subject of the contract becomes various types of securities, most often shares of large companies.
  At the moment, this type of contract is a favorite source of income for many traders, since predicting the behavior of stock prices is much easier than that of commodities or currencies. After all, the operations of most companies are fully visible to ordinary people, and the basic law of economics states that any action of a firm can affect the price of its shares.
  In addition to generating profit, they are often used for hedging — insuring funds invested in one financial transaction with another financial transaction.

 

Currency option

  As the name implies, such a sell option gives the right to sell foreign currency. They are sometimes called FX options, that is, FOREX, since it is on this market that they are most often implemented.
  Since a favorite method of trading is buying and reselling currency, currency sell options are especially popular. Most often they are used to hedge large investments. With the help of such a contract, a trader can recover the funds spent on purchasing currency in the event of a collapse.

 

Commodity sell options

  They are often confused with futures and forward contracts. They give their holder the right to sell goods, for example, minerals, precious metals and stones, or crops.
  Traders acquire them, again, for hedging. Producers of goods themselves also often purchase such securities, acting as producers of the underlying asset. Most often, producers of seasonal goods or goods with a short shelf life are involved. In this way, they insure themselves not only against financial losses, but also against spoilage of goods: in some situations, the question is not about making a profit, but at least about recovering the invested funds.
 

Application of sell options

  As you have already understood, contracts can be used for two purposes: making a profit and hedging.

 

Making a profit

  When acquiring a put option, a trader counts on fluctuations in the value of the asset that can positively affect their own financial situation. The transaction is concluded if the buyer is confident in an imminent decrease in the value of the asset.
  This type of investment is very convenient because, essentially, there is no need to spend any funds; in most cases, the trader and the seller conclude cash-settled options, as a result of which one party simply pays profit to the other if the outcome of the transaction turns out unfavorable. A sell option is one of the few ways to earn money from a decrease in the value of an asset rather than from its increase.

 

  Example:
  The behavior of the financial market indicates an imminent decline in the value of the shares of a large company. An experienced trader, deciding to take advantage of this, acquires a sell option. The seller of the security undertakes to buy from the trader the specified number of shares at the price valid at the moment, say 500 rubles per share. The maximum possible number of shares sold is 1,000.
  Since the seller of the security also monitors the market, they are aware of the possibility of an imminent decline and therefore set a fairly high option price — 8% of the investment amount. It turns out that the buyer must pay 1,000 rubles (option price) * 500 shares * 8% = 40 thousand rubles in premiums.
  The transaction is concluded, and soon the shares indeed begin to fall in price. At the moment of option execution, their price is already 425 rubles, that is, it has fallen by as much as 15%. The trader buys up the company’s shares at this low price, especially since due to such a sharp decline there are many people willing to get rid of an unprofitable asset.
  Then the trader sells these shares to the option seller at the agreed price. Their profit will equal 15% growth minus the 8% premium = 7% of the amount spent on purchasing the shares at the old price, that is, 35 thousand rubles.

 

Hedging investments

 

  Hedging is an integral part of a competent exchange trading strategy. Experienced players increasingly avoid investing large sums in currency or shares without additional insurance. In an ideal scenario, the investor should not use the acquired right at all. This means that their strategy turned out to be correct and there was no need to use fallback options.
  The option premium significantly reduces potential profit in a favorable outcome, but such a transaction reduces the chance of possible losses.

  The acquisition of commodity options by producers of these very goods can also be attributed to hedging.

 

Example:
  A small manufacturer of a certain type of goods is experiencing difficulties: due to a financial crisis, demand for its products has sharply fallen, and the chance that the next batch will be unclaimed is very high. For insurance, the company acquires a sell option for its products at a price slightly below the market price. The strike price has to be lowered because the contract must be long-term (2 months), and because of this the seller of the security has the right to increase the premium level: otherwise, it would simply be unprofitable for the producer to conclude such a contract. The specified price covers the cost of production and even provides a small profit of 20% of it. The option price equals 8% of the cost price.
  The subsequent batch of goods indeed turned out to be unclaimed, and in order to avoid bankruptcy the company had to use the previously acquired document. It not only covered the cost of the goods, but also made it possible to obtain, albeit a small, but still profit of 12% of the cost price, that is, 20% minus the 8% premium. This income made it possible to ensure the operation of the company for several more months.