What Is a Physical Option?

A physical option is a type of investment option that provides the investor with the opportunity to purchase or sell some type of physical asset, with both the price and the date of the transaction established as part of the terms. Assets that are included in this type of option arrangement can include just about anything that is tangible, such as various types of currencies, commodities, government-issued debts, and even real estate. This is different from other options that deal with non-physical assets such as stocks, indexes, or futures contracts.

The structure of a physical option is similar to any type of stock or other investment option. The terms of the option will allow the investor to purchase or sell the option with specific provisions related to the price of the asset that is being offered, as well as a limited time frame in which the transaction can occur at that stated price. Investors may sometimes use a combined physical option strategy that involves securing a call option along with a put option for a similar type of physical asset. This strategy makes it possible to take advantage of whatever may happen in terms of the market value of the asset, and likely generate a net profit off the combination of the purchase and sale related to each of the two options.

Along with commodities like gold, corn, or pork bellies, the range of assets that may be involved with a physical option also include energy options, such as an option created on electricity. In order to define what can and cannot be used as the underlying asset for a physical option, most options exchanges provide detailed information about which assets maybe involved with options traded within that exchange. This information can be very helpful for investors, since it aids in defining what is and is not classed as a physical asset according to the standards set by the exchange.

As with most investment options, the creation and execution of a physical option does carry some degree of risk. When buying options of this type, the expectation is that the asset will increase significantly in value before the expiration date defined in the option terms. Assuming the asset does increase in market value and is commanding a price much higher than the one defined in the option, the investor can choose to exercise the right to purchase the asset at that lower price, then sell the asset for a significant profit. Should he asset fail to perform as anticipated, this could mean lower returns if the option is exercised or a complete failure to generate any amount of return from the deal.