Option Fundamentals   • 5
Options in Daily Life
The type of option with which people living in developed economies are 
most familiar is an insurance contract. Let’s say that you want to fully insure 
your $30,000 car. Y ou sign a contract (option characteristic number 1)  
with your insurance company that covers you for a specified amount of time 
(option characteristic number 2)—let’s say one year. If during the coverage 
period your car is totaled, your insurance company buys your wreck of a 
car (worth $0 or close to it) for $30,000—allowing you to buy an identical 
car. When this happens, you as the car owner (or investor in a real asset)  
realize a profit of $30,000 over the market value of your destroyed car  
(option characteristic number 3). Obviously, the insurance company is 
bound to uphold its promise to indemnify you from loss for the entire term 
of the contract; the fact that you have a right to sell a worthless car to your 
insurance company for the price you paid for it implies that the insurance 
has value during its entire term (option characteristic number 4). 
Another type of option, while perhaps not as widely used by everyday 
folks, is easily recognizable. Imagine that you are a struggling author who 
has just penned your first novel. The novel was not a great seller, but one day 
you get a call from a movie producer offering you $50,000 for the right to 
draft a screenplay based on your work. This payment will grant the producer 
exclusive right (option characteristic number 1) to turn the novel into a 
movie, as well as the right to all proceeds from a potential future movie 
for a specific period of time (option characteristic number 2)—let’s say  
10 years. After that period is up, you as the author are free to renegotiate an-
other contract. As a struggling artist working in an unfulfilling day job, you 
happily agree to the deal. Three weeks later, a popular daytime talk show 
host features your novel on her show, and suddenly, you have a New York 
Times bestseller on your hands. The value of your literary work has gone 
from slight to great in a single week. Now the movie producer hires the 
Cohen brothers to adapt your film to the screen and hires George Clooney, 
Matt Damon, and Julia Roberts to star in the movie. When it is released, 
the film breaks records at the box office. How much does the producer pay 
to you? Nothing. The producer had a contractual right to profit from the 
screenplay based on your work. When the producer bought this right, your 
literary work was not worth much; suddenly, it is worth a great deal, and