When you have choices, you get better answers to meaningful problems. The future is unknown and the cost to get absolute control is near infinite. Options provide a way to get control without spending as much as a purchase would require.
Suppose you might need some asset in the future. Maybe it is the land beside your factory, or the movie rights to a book, or a lease allowing oil exploration. In all cases, you could just buy the property, but most do not. After all, you might not be able to use it and will have tied up scarce capital to no advantage.
The question is an important one
How can I control something I might need in the future without tying up too much capital? Most businesses own assets because they use them not because they want to own them necessarily. Ownership is a degree of control, but expensive. Leasing is fine but for shorter periods than forever. Those work when you know you must use the asset.
When you don’t know you will need to use it or not, many people use an option.
An option is a contract that provides the right to choose for a fee. They may be simple or complex. In the book case, a producer may acquire the right to choose to turn the book into a movie script and produce a movie from there. The option provides control while studying feasibility. It costs much less than a purchase where the control element is complete, but if the movie seems infeasible, what do you do with the rights? Options are about inexpensive, usually time limited control of an asset that may have use.
In the stock market you can purchase options. A call option gives you the right to buy a security at a fixed price for a period of time. The premium you pay may be lost if the call expires before the security rises enough to validate the price you paid. A put option gives you the right to force someone to buy a security from you at a given price for a given time. Again you may lose your premium should the security’s market price move against you.
Some managers write options on their portfolio as an additional source of revenue. Usually funds that are more interested in income than capital appreciation.
Speculators often use call options as a way to participate in a stocks movement without paying the price to buy it.
Options look simple but are subtly complex. Be vary cautious until you understand them. Recall Buffett. “Risk is what happens when you don’t know what you are doing.”
Insurance is a form of option
Take life insurance. There is a small probability that a healthy person might die in the coming year. Their family might need a very large capital sum to replace their expected earnings. If they don’t have the money at hand, they will suffer. Like the movie producer, not knowing if the need is there, the person acquires an option on money to be delivered on the happening of some event. Death.
Other forms of insurance operate on the same sense of optionality.
The premium or fee for the option is tiny compared to the capital controlled. It’s tiny because the probability of the event is tiny.
Life insurance contracts come in many forms. The form of contract deals with many things. How long will the option exist. Term insurance is like this. The premium to cover a long time is higher than for a short time. The premium for all of life is higher still. But that form of insurance comes with a different option. Should you decide to discontinue the option, some forms of coverage will allow you to receive a refund of part of the money you paid. Some forms are rigid, others flexible.
You can usually find a budget sensitive plan that addresses your particular needs.
Options are a way to control access to some asset without owning it
Options are usually more affordable than purchasing the asset.
Options are a useful way for people to influence what happens in the future.
I help people have more retirement income and larger, more liquid estates.