DEFINITION of 'Seller's Option'

A seller's option is the right of a forward contract seller to choose some of the specifications of the underlying security or commodity to be delivered. The choices about the delivered commodity's or asset's quality and delivery specifications must fit within the pre-established limits imposed by the terms of the contract. A seller's option is useful for making good on physical delivery without having to worry so much about the stringent specifications set out in standardized contracts such as listed futures contracts. A seller's option may also provide some flexibility with regard to the exact settlement date and delivery date.

A seller's option may also refer to a put option, since the owner of a put has the right to sell the underlying security at a specified price.

BREAKING DOWN 'Seller's Option'

A seller's option gives the short in a forward contract the ability to work with the long side of the contract to ensure delivery is fulfilled, but where the seller can choose exactly what to deliver, within the scope of the contract.

A seller's option is most commonly employed in forwards on physical commodities. For some commodities, such as rice and oil, collecting suitable amounts of a commodity and providing the transportation can be a very complicated and indeed costly process. For example, a forward contract for corn can represent 5,000 bushels. Since hedgers tend to buy large numbers of contracts at a given time, a forward contract seller might have to deliver hundreds of thousands of corn bushels during a single delivery window. Giving contract sellers a little bit of leeway can alleviate some of the difficulties involved with delivery logistics.

Seller's Option: Cheapest to Deliver in Bond Futures

A seller's option also comes into play with in bond derivatives markets with cheapest to deliver (CTD) contracts. This feature is common in treasury bond futures contracts, which will typically specify that any qualified treasury bond can be delivered so long as it is within a certain maturity range and has a certain coupon rate. Determining the cheapest to deliver security is important for the short position, and this seller's option makes it advantageous for the seller to pick a specific security to deliver over another in their book in order to maximize their profit. However, since it is to be assumed that the short position will always provide the cheapest to deliver security, the market generally prices these futures contracts based on the cheapest to delivery security anyway.

RELATED TERMS
  1. Seller's Market

    A seller's market is a market condition characterized by a shortage ...
  2. Delivery Price

    The delivery price is the price at which one party agrees to ...
  3. Minimum Price Contract

    A minimum price contract is a forward contract that guarantees ...
  4. Options On Futures

    An option on futures gives the holder the right, but not the ...
  5. Best To Deliver

    Best to deliver is the security underlying a futures contract, ...
  6. Forward Contract

    A customized contract between two parties to buy or sell an asset ...
Related Articles
  1. Investing

    The Ins And Outs of Seller-Financed Real Estate Deals

    There's more than one way to buy or sell a house. Seller financing presents yet another unique option.
  2. Trading

    A Quick Guide To Debt Options

    Options on debt instruments provide an effective way for investors to manage interest rate exposure and benefit from price volatility, learn more today.
  3. Investing

    What are Options Contracts?

    An explanation of options contracts, call options and put options.
  4. Trading

    The Ins and Outs of Selling Options

    Selling options can seem intimidating, but with these tips you can enter the market with confidence.
  5. Investing

    What is a Forward Contract?

    A forward contract is a customized contract between two parties to buy or sell an asset at a specified price on a future date.
  6. Trading

    Beginner's Guide To Trading Futures

    An in-depth look into what futures are, and how you can build a solid base to begin trading them.
  7. Investing

    7 Tips for Writing a Homebuyer’s Letter to a Seller

    To win a real estate bidding war, use these seven tips for writing a homebuyer’s letter to a seller that’s engaging and personal.
RELATED FAQS
  1. Here's What Short Sellers Must Do to Short a Stock

    Learn what benefits a short seller is required to make up to the lender of shares, or long investor, when shorting a stock ... Read Answer >>
  2. How is the price of a derivative determined?

    Learn how different types of derivatives are priced, including how futures contracts are valued and the Black-Scholes option ... Read Answer >>
  3. What is the difference between open interest and volume?

    Learn how to interpret the relationships between price, volume and open interest in the options and futures markets. Read Answer >>
  4. What is the difference between derivatives and options?

    A derivative is a financial contract that gets its value from an underlying asset. Options offer one type of common derivative. Read Answer >>
Trading Center