I understand that buying an option gives you the right to sell a certain stock at the strike price, but what is the point of this? How can you profit from guessing right, and is there any advantages to options that stocks don’t have?
In: Economics
Suppose you’re a farmer, and you’re pretty sure you’re going to harvest at least 75,000 bushels of corn, but maybe as much as 100,000. But you need to know, in advance, how much money you’re going to get for it, so you can plan about how much money you’re willing to spend optimizing your crop.
You can sell contracts on 75,000 bushels (for delivery at harvest time) right now, and lock in a price, but what about the 25,000 maybes? You can’t guarantee that you’ll be able to deliver them. So what you can do is buy put options on that amount. That guarantees that, even if the bottom falls out of the market, you’ll get at least the strike price for them (minus the options’ cost). If it’s not a good harvest, you can just let the options expire.
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