Optionality
options · preserving options
The value held in an asymmetry: a right to act without an obligation to, so that good outcomes can be taken and bad ones declined. Option pricing (Black & Scholes, 1973) established that this asymmetry is worth money, and that it is worth more the more uncertain the underlying is.
In practice
Two contracts, same fee. One runs twelve months with a termination penalty; the other runs month to month. The second is worth less per month and more in total, because the month in which the client's business changes is the month it stops costing you.
The common mistake
Treating optionality as free. Every option has a premium — the retainer you did not sign, the role you did not take, the specialisation you did not build — and it decays. A portfolio of unexercised options is not a strategy; it is a slowly emptying account.
An option is a right without an obligation. That asymmetry has a price, and the whole content of the concept is what determines it and who ends up paying it.
Where the value comes from
Fischer Black and Myron Scholes (1973), with Robert Merton's formulation the same year, showed that the right to act is a priceable asset. The finding that matters outside finance is the direction of one comparative static: an option is worth more when the underlying is more volatileBlack, F. & Scholes, M. (1973). 'The Pricing of Options and Corporate Liabilities.' Journal of Political Economy 81(3); Merton, R. C. (1973). 'Theory of Rational Option Pricing.' Bell Journal of Economics 4(1). Because the downside is capped at the premium while the upside is not, greater dispersion raises expected payoff — the opposite of the effect volatility has on an obligation.. Uncertainty is bad for a commitment and good for a right, which is why the two should be held in opposite circumstances.
Avinash Dixit and Robert Pindyck (1994) carried this into ordinary investment decisions. Where a commitment is irreversible and information will arrive, the option to wait has positive value, and a project with positive net present value can still be worth postponing. This is the formal answer to why sensible people decline profitable-looking opportunities. Nassim Taleb (2012) supplies the behavioural programme: seek positions whose downside is bounded and upside is not, and accept that most will expire worthless.
The premium, which is the part left out
Popular versions of optionality present it as costless — keep your options open, stay flexible, commit to nothing. Options markets say otherwise: you buy the asymmetry, and the price is paid whether or not you exercise. Outside finance the premium is paid in foregone depth. The person who keeps every career option open pays in the specialisation they never built; the business that serves every segment pays in the position it never occupied. Both are real costs, neither appears anywhere, and both compound in the wrong direction.
Options also decay. A right that is never exercised expires, and the analogous decay in a career or a business is the narrowing of the options themselves: the set available at forty is a function of what was committed to at thirty. Held indefinitely, optionality converts into its opposite.
The objections
The finance analogy is loose in one decisive respect. Financial options have a defined exercise date, a stated strike and a known premium; life options have none of the three, so the reasoning that makes the mathematics work does not transfer. Calling a career choice an option imports precision that the situation does not contain.
There is also a selection problem in the advice. Optionality is most often recommended by people whose options were unusually good, and for whom holding out was cheap. For someone whose available options are all similar, the strategy collects nothing and pays the premium anyway — and the commitment they declined was the mechanism by which better options would have been generated.
What it rules out
It rules out treating flexibility as free. It rules out symmetric exposures dressed up as options — if the downside is unbounded, it is not an option, it is a position. And it rules out net present value alone as a decision rule where a commitment is irreversible and information is still arriving, which is Dixit and Pindyck's result.
It does not rule out commitment. It prices it: commitment is the sale of an option, and the question is whether the premium received — depth, reputation, compounding — exceeds the value of the right given up. Frequently it does.
Sources
Black, F. & Scholes, M. (1973). 'The Pricing of Options and Corporate Liabilities.' Journal of Political Economy 81(3). · Dixit, A. & Pindyck, R. (1994). Investment Under Uncertainty. Princeton University Press. · Merton, R. C. (1973). 'Theory of Rational Option Pricing.' Bell Journal of Economics 4(1). · Taleb, N. N. (2012). Antifragile. Random House.
Concept web
Open the full webQuestions
What is optionality?
The value held in an asymmetry: a right to act without an obligation to, so good outcomes can be taken and bad ones declined. Black and Scholes (1973) established that this asymmetry is priceable and that it is worth more the more uncertain the underlying is.
Is keeping your options open free?
No. Every option carries a premium, paid whether or not it is exercised. Outside finance the premium is foregone depth — the specialisation not built, the position not occupied — and it does not appear in any account.
Why can a profitable project be worth postponing?
Because the option to wait has value when a commitment is irreversible and information is still arriving. Dixit and Pindyck (1994) showed a project with positive net present value can still be worth delaying, which is the formal answer to why sensible people decline good-looking opportunities.
What is wrong with the optionality analogy?
Financial options have a defined expiry, strike and premium; career and business options have none of the three, so the mathematics does not transfer. Held indefinitely, optionality also decays: the options available later are a function of what was committed to earlier.