Physical Option

A physical option is an options contract that, if exercised, results in the actual delivery of the underlying asset rather than a cash payment. The "physical" refers to how the contract settles, not necessarily to whether the underlying is a tangible commodity like gold or oil — currencies, bonds, and physical commodities can all be traded this way, and the key feature is that ownership of the real asset changes hands.

When someone exercises a physical option, the seller (the person who wrote the option) must deliver the actual underlying — say, barrels of oil, an amount of foreign currency, or a bond — to the buyer, who pays the agreed strike price for it. This is different from a cash-settled option, where instead of handing over the asset, the two sides simply exchange the cash difference between the strike price and the market price at expiration.

The nuance that trips people up is confusing "physical" with "commodity." Many equity options are technically physically settled too — if you exercise a call option on a stock, you actually receive shares, not cash. So "physical option" in the strictest sense just means physical delivery, and it happens to be common in commodity, currency, and bond markets because those are markets where actual delivery of the underlying is a normal, expected outcome of trading.

Physical settlement also brings logistical considerations that cash settlement doesn't: storage, transport, quality specifications for commodities, or settlement mechanics for currencies and bonds. This is one reason many retail-facing markets favor cash-settled products, since most traders have no interest in taking delivery of a tanker of crude oil.