Shearing: Click "Shear" on a sheep or use shears on it. Wool drops as items. Sheep regrow wool after about a minute.
Spinning: Use the spinning wheel in Lumbridge Castle. Each piece of wool becomes one ball of wool. You get extra Crafting XP for doing this yourself.
Fastest method: Simply buy 20 balls of wool from the Grand Exchange and deliver them directly to Fred - no shearing or spinning needed.