Real Estate Option
Real estate options are similar to stock options, with land or a dwelling
used as the underlying asset.
For example, while shopping the want ads, you find a piece of property that
is being sold for $50,000. You are interested in the land, but aren't sure
you'll be able to come up with money or be qualified for the loan. In this
case you can purchase an option on the land. Under these circumstances, you
would approach the owner and offer him an option to buy the property. This
option gives you the right, but not the obligation, to buy the property for
the specified price on or before a specific date.
Perhaps you give the owner $1,000 for a six-month option. This means you have
six months to exercise the option and purchase the property. It also means
the seller is obligated to sell you the property for the agreed-upon price,
if you request. It also means you, the buyer, can walk away from the
transaction and forfeit only the price you paid for the option. In most cases
you can also assign your option to another party, who can take advantage of
the option in your stead.
Say, for example, you found a modest home in your community that was priced
at $100,000. You gave the owner $1,000 for a three-month option on the
property.
The next day you learn that the house was the summer home for former
President Woodrow Wilson. Word gets out and suddenly the value of the
property triples overnight. The good news: Because you bought the option,
you may still buy the house for $100,000, even though it's worth $300,000.
The bad news: The seller won't be happy, but there's nothing they can do
about it.
But say you find out that same day that the house is insulated with asbestos
and all the walls are covered with lead-based paint. The government finds
out and has now labeled the home uninhabitable. Now the $100,000 home is
almost worthless. The good news: Because you bought the option, you can walk
away from the deal and lose only the cost of the option, in this case $1,000.
The bad news: The seller won't be happy this time, either, but there's
nothing they can do about it, other than pocket the price of the option.
Types of Financial Options
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