What Is an Option in Real Estate? What You Need to Know

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Written By Justin McGill

DealBloom aims to share the latest tips and strategies to help realtors, brokers, loan officers, and investors navigate the world of real estate.

If you’re considering purchasing a property, you may come across the term “option.” But what is an option in real estate? Here’s everything you need to know about this type of contract.

I remember when I was first looking at properties, I came across one that said it was under option. At the time, I had no idea what that meant and ended up passing on the opportunity to purchase it. If only I had known then what I know now!

What is an option in real estate? An option gives the buyer the right, but not the obligation, to purchase a property within a certain period of time. The seller agrees to hold off on selling the property during this timeframe and usually charges a fee for doing so. This can be beneficial for both parties as it allows buyers more time to secure financing and figure out if they really want to go through with purchasing the home. It also protects sellers from having their property taken off the market while they wait for buyers who may end up backing out anyway.

What Is an Option in Real Estate?

An option is a contract that gives the holder the right to buy or sell an asset at a pre-determined price and time.

The asset can be anything, such as stocks, commodities, currencies, interest rates, or pieces of property.

In an option’s agreement, consideration is the exchange of something valuable for something else.

In options contracts, buyers give up money as consideration for the right to buy or sell a security at a predetermined price. The seller, on the other hand, has to give up something valuable in order to consummate the transaction. This comes in the form of losing out on the chance to earn more money by selling the assets at a better price or buying more at a cheaper rate.

Options contracts in financial markets are bought and sold on stock exchanges and over the counter.

The pricing of options in finance is determined by a number of factors, including the strike price, the expiration of the option, and the particular type of contract.

What are the Elements of an Options Contract?

  • Underlying asset: The investment that an option gives its buyer the right to choose whether to buy or to sell.
  • Strike price: The price at which the holder can buy or sell the asset.
  • Expiration date: The date on which the option contract expires.
  • Premium: The price of the option contract paid by the holder to the seller when the contract is purchased.
  • Exercise price: The price at which the holder can exercise their option to buy or sell the asset.
  • Type of option: Call options or put options.

Options Contracts Explained

To better grasp how stock options work, it’s important to understand the difference between a call option and a put option.

A call option gives the holder the right to buy the asset at the strike price on or before the expiration date.

The buyer of a call option believes that the price of the underlying asset will rise and they can sell it for a profit.

The buyer of a put option hopes that the price of the asset goes down so they can buy it at a lower price to make a profit.

When trading options, someone is said to be ‘long’ if they are buying a call option or ‘short’ if they are buying a put option.

When entering into an options contract, it is important to be aware of the options chain. The options chain lists all available option contracts for a particular underlying asset.

This includes strike prices and expiration dates for both call options and put options. The most active options contracts are always listed at the top of the chain.

The options with the most activity are the option contracts with the most trade volume. Contract fees are another factor that you should consider.

An options-per-contract fee is a charge assessed by your broker for each options contract that is bought or sold. Some brokers also assess a separate commission on options trades, which is typically a percentage of the trade value in addition to the per-contract fee. This provides flexibility to traders as there are many different ways to trade options.

Some popular options strategies include buying a call, buying a put, writing a call, and writing a put.

When purchasing a call, buyers hope that the price of the stock or commodity will increase so that they can exercise their options and buy the stock or commodity at a cheaper price and then sell it at a profit.

When buying a put, the buyer is looking to profit from a decline in the price of the underlying asset. By exercising their option to sell the asset at a higher price and then buying it back at a lower price, they can make a profit.

When writing a call, the trader hopes the price of the stock stays the same or falls so that they can keep the full value of the option.

If the price of the stock goes up, the trader may sell the stock at less than what it is worth.

When writing a put, the buyer hopes the price of the stock will stay or fall so that they can keep the money they paid for the option.

If the price of the underlying asset falls, the seller may have to buy the asset at a higher price than what it is currently worth.

Options contracts are commonly used for speculation, hedging, income generation, and portfolio protection.

Elements of an Option Contract in Real Estate

A letter of intent is often the first step to a deal involving the purchase of an option contract. A letter of interest is non-binding and outlines the terms of the agreement.

It may become binding if both parties agree to the terms. After the letter of intent, a finalized written contract must be created.

The contract should include the names of all parties involved, the address of the property being purchased, a date by which the purchase must be made, and the final purchase price.

These are the key elements that make up an option in real estate: a contract in writing, the property location, a timeframe, and a final purchase price. Without all four, the option contract is not valid.

There may also be specific terms in these real estate contracts that are important to note such as “earnest money” or “deposit money.”

An earnest money deposit is not always required, but when it is, it goes into an escrow account until the closing date. The amount of the deposit may be refundable or non-refundable depending on the contract.

It is always a good idea to have an attorney review any contracts before agreeing to them. This is because many complex legal terms may be included in a contract, and these may negatively impact you.

Conclusion

What is an option in real estate? An option gives the buyer the right, but not the obligation, to purchase a property within a certain period of time. The seller agrees to hold off on selling the property during this timeframe and usually charges a fee for doing so. This can be beneficial for both parties as it allows buyers more time to secure financing and figure out if they really want to go through with purchasing the home. It also protects sellers from having their homes taken off the market while they wait for buyers who may end up backing out anyway. So if you’re considering an option contract when buying a home, now you know what it is and how it works!

Justin McGill