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