Three Types of Real Options

Let’s take a closer look at the three important types of real options in your life. Once you are familiar with them, you might see the world around you with new eyes. Thinking in options can be very powerful as it helps rational decision making. If you have not already done so, please read the blog post on understanding financial and real options in life first.

Growth Option

A growth option is like a financial call option. You invest a bit of money into something that might have a high pay-off under certain conditions but that cannot be guaranteed at the time of acquiring the option. That’s what venture capitalists do. But you can do so as well. Think about the photography classes you took in high school for fun. Beyond a simple hobby, you might be able to convert your skills into extra income. Or let’s assume that you found a start-up with your buddy to develop the next mega app. This is a pure growth option as everything is hope and you will have zero or not much income at the beginning.

Because many growth options expire worthless, ideally you should invest in several with the idea that at least one might do well enough to offset the cost of the others. One example of such a strategy would be to pay extra to enroll in a more reputable master’s program, and learn Spanish during your studies as well. You don’t know whether you can monetize the new language later, nor whether the added master’s program costs will make a difference in job opportunities when you graduate. Hence, acquire both options.

Defensive Option – Insurance

A defensive option (often called insurance) is equally important but is often overlooked. It’s comparable to a put option in financial markets. Think about renter’s insurance. You pay for the option to have the insurance company to bail you out in case you let the bathtub flow over and your carelessness causes damage in the floor below. The option price is the insurance premium you pay, and the duration of the option is the length of the insurance contract, which probably matches the duration of the lease. You hope you never have to exercise the option (hey, dealing with the insurance companies is not much fun), but if something bad happens, the insurance is there for you.

In the realm of our rallying cry of “Go Global Be Happy,” here is another example for an option that might help you out if the situation in your country become unbearable: a second passport. This allows you to leave your location if and when things go south. Remember the last helicopters out of Vietnam in 1975 – those without US passports and green cards were left behind.

Option to Wait

A third type of option that is truly valuable is the option to wait. Delaying decisions often has value as new information emerges. This might be a hard fact to accept for a hot shot who is ready to immediately go at things that look promising. Let’s say you have a business idea but you feel the world is not ready yet for your flying e-scooters. Instead of starting your venture right now, you monitor the situation and invest every month in more research. Once the time comes, you will be ready. If the time never comes, then your monthly small investments are you lost; but that’s better than going in full throttle as soon as you have an idea and lose spectacularly.

Another example would be to not look for a new job after having lost one in a recession. If you have some savings, then waiting for better times and better job offers might be worth the cost of foregoing income for a while.

Patience might not always be a virtue, but it often is.

Takeaway

Seeing your life through the lenses of real options helps you make better decisions. Always ask yourself whether waiting can improve your odds before going ahead with something. When it comes to looking at the potential upside or downside, analyze whether there is a way to acquire a reasonably-priced option that could offer a great payoff if future circumstances allow you to trigger its exercise. Now, sit down, have a coffee, and list which attractive growth options you already have in your life and which ones you should consider procuring.  Make sure you cover your ass with that renter’s (or, if you own your residence, homeowner’s) insurance. Spending a mere $100 can keep you from going bankrupt in that unlikely but entirely possible scenario of you causing damage to your neighbors.

PS: Here is an extra bonus to this post for curious readers like you. Before you get married, understand the call and put options attached to that relationship. Remember the option to wait? Just saying…but that’s a topic for another day.

© Michael Froehls – 2019 – All Rights Reserved