I understand how buying them works but I’m looking at selling and it doesn’t seem to make sense. More importantly, what happens when they expire?
In: Economics
Options are the _option_ but not the _obligation_ to buy (or sell) some defined instrument for some set price at some date in the future.
You can buy options based on what you think the _future_ market is going to do. You can potentially lock in a cheap price on an instrument at a future date. If you think the price of stock X is going to go up, you can buy options for a low price at a future date. That will allow you to buy X at a cheap price and sell them right away for a higher price if you like. If the price doesn’t do what you think it will in the future, you can choose to not exercise your option.
Also – and least for 5 year olds – options can be used to generate _synthetic exposure_ for a portfolio. If you hold options for a contract, you can count those shares as exposure in your portfolio without paying for the actual underlying instruments. Options do have a price themselves but that price is very small. So you can spend a little bit of money to buy options, then use the option price as the value of your instruments in your portfolio. For this purpose options usually aren’t exercised, but sold and re-bought when they expire.
For instance – you want exposure to the S&P500 index but you don’t want to buy the actual stocks. You can buy options and use the option price as your exposure to S&P500 without spending the cash on actual shares. But then you have to sell and re-buy when they expire, otherwise you will no longer hold the virtual (synthetic) exposure.
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