Optionality — A trap or a tool

I wanted to write about Options. But honestly, it is a bit technical for me, too early for this blog, and extremely boring for non-finance people. So, a friend suggested I should write on Optionality instead.

Optionality is interesting. And it is omnipresent in our life, profession, relationships everywhere.

It is derived from Options, a contract in the financial world that give you a right to do something, but you are not obligated to do it. And you pay some premium to buy this right.

If you wish, you can exercise the option. If you don’t, you can walk away and the only thing it costs you is the Premium you paid.

Say you want to buy a building with four floors. I have one such building that would be available for sale in a few months.

But you want to find buyers for each floor first. You pay me Rs 5 lakh for a right to buy the property from me anytime within 1 year for 1 Crore.

Since I have given you the right and collected a premium, I can’t sell it to anyone till our contract period is over. If in this 1 year, you are able to find the
buyers, you will exercise the option to buy the property from me and pay me 1Crore.

But because it is an option, if in case you are unable to find the buyers, you will walk away from the contract and your maximum loss is the Premium you paid me.

You see what you did here? You made a deal that had limited downside but unlimited upside.

The downside was maximum 5 lakh (the premium). The upside was as high a price you could get for a floor.

If you sell each floor for 35 lakh, you make 35 lakh in this deal.

If you sell each floor for 50 lakh, you make 95 lakh in this deal.

Through that contract you widened your scope of possibility without any obligation.

That’s optionality. A state of having a discretion of choice, but no obligation.

Okay, really, what does it mean?

When you take PCM-B, PCM-E, PCM-IT (Physics, Chemistry, Maths — biology, economics, information technology) etc in 11th standard, everything after the hyphen “-” is optionality. It gives you an option to pursue these fields IF PCM does not result in a good engineering college.

When you study engineering and work in IT firms, it is optionality. It gives you an option to not work in the technical stuff that you anyways never understood or liked.

When you do MBA , it is “optionality”. It gives you an option to do “anything”. I don’t think there is anything more vague and open ended than “management”.

When you date on Tinder or meet “prospective arranged partners” for months together unable to finalize the one person to annoy (or get annoyed from) for rest your life, it is optionality. Finding that one person will mean shutting down all other options and who wants THAT!

When you jump from garment to consulting to entrepreneurship to finance while writing a blog about what it resulted in (yes, yours truly), it is optionality.

Optionality are the options you buy for yourself, at some cost (not always quantitative or visible) that give you a right to do something but does not tie you to it with any commitment!

Isn’t it perfect!

Well, some people, and very renowned people at that call it a trap.

Some swear by it.

The financial world pretty much thrives on it.

In finance, you deal with money and obviously want to limit the downside (losses) and so optionality makes sense. So you diversify your investments and increase options for profit making while aiming at preserving your capital. Then you buy Options to further safeguard your investments in stock market.

You accumulate emergency fund to create a possibility of a choice. Choice to get out of an unpleasant situation in job or life. Without the emergency fund, there is no option. The job or the person that feeds your family becomes indispensable. But when you have money and an option to walk out, you step back and have an option to think about the situation in a more practical manner

The entire idea of investing your money is to build optionality in your life. Option to retire early, option to take a break, option to buy a car, option to not be controlled by money. Isn’t it?

These are all options. Whether you exercise it or not is for later.

The Freelancing industry is built on it

You know what the biggest upside of freelancing is — optionality. Option to schedule your calendar as you wish. Option to do what you do best. Option to work on multiple projects at a time.

When you build a skill, you are giving yourself an option to use that skill at a later date with a hope that the benefits will be greater than what your current job presents you with.

Full time freelancers are the people who have built that skill and exercised their option too.

So why is it a trap?

It is a trap when you keep on building the options without ever exercising any one. There is someone who explained this thought better.

Very famously explained by Mihir Desai, Professor of Finance at Harvard Business School:

“The Yale undergraduate goes to work at McKinsey for two years, then comes to Harvard Business School, then graduates and goes to work Goldman Sachs and leaves after several years to work at Blackstone. Optionality abounds!

This individual has merely acquired stamps of approval and has acquired safety net upon safety net. These safety nets don’t end up enabling big risk-taking — individuals just become habitual acquirers of safety nets.”

So you keep on building options, building skills, adding degrees, changing companies to broaden your options but never ever exercising it. He explained further that the comfort of the job overpowers the very purpose why you were acquiring all those skills and certificates.

He also emphasises that for some people a comfortable job is a dream come true. And that’s great.

But for a lot of others, the real dream, the real purpose of acquiring all those skills and degree — the dream — takes a backseat just because they don’t exercise their option.

Because the comfort is too cozy to risk. Because “the time is not right yet”.

So where do you stand?

I concur, mainly because this realisation that all you are doing is acquiring safety nets is what peaks your mind when you finally decide to follow your passion.

It happened with me, it happened with M and it happened with a whole lot of other entrepreneurs/freelancers/artists that I know.

The thought is, “What’s the point if I don’t even pursue what all this was meant for”.

What the professor said here is actually what precedes the action of breaking out and deciding to follow your passion.

Exercising your option still entails some degree of risk-taking. For that small downside (loss/failure) that is inherent in an option.

All we did was exercised our option. We took the risk. We did not fall in the trap of building optionality without ever exercising it.

At the same time, I think building optionality is important. The times are uncertain, the takeover by technology is making most of the human workforce redundant and freelancing and contractual work is making it more difficult for a regular salaried employee.

Optionality helps you stay relevant, useful and build a parallel income source.

Yes, I still plan on building new skills and upgrading myself to maximize optionality. To have it all ready when I want to use it. I also intend to exercise it, few years down the line. This time with better financial planning.

Last time our choices got judged when actually our planning was flawed, not our choices.

Optionality is great when it does not become a habit of only accumulating options and taking approval stamps. You have to exercise it every once in a while.

How else would you even know if it can make you a profit? If all what you are doing is even worth it or not?

Originally published at She Talk Cents.

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