Free Call Options: Better Than Free Beer

Introduction to Stock Options

Stock options are financial contracts that grant you the right to buy or sell shares of a certain stock at a strike price (fixed price) before a particular expiration date regardless of the stock’s market price.  Call options allow you to buy the respective stock at a fixed strike price (and its counterpart, Put options, allow you to sell the same stock at a fixed strike price.)  Suppose you have a Call option on a stock currently trading for $50, a strike of $55, and an expiration a year from now.  Suppose the same stock starts trading for $100 a year from now.  You can exercise (execute) the call option and pay $55 to buy a $100 stock.  And if you sell it right away, you’d pocket $45 in profit.  However, if that stock plunged down to $10 in a year, you would have lost nothing whereas a stockholder would have lost $40 for every share of stock owned.  Essentially, if you’re in possession of a call option, you have no downside and unlimited upside, unlike the owning stock directly.

Because of the Call option’s unlimited upside and lack of downside, Options Dealers will charge you a premium to buy such options (probably around $5-10 for the option discussed previously.)  How these dealers and the Options markets price these Options is beyond the scope of my article but this premium is usually high enough so that most Options dealers will not go broke in the long run but low enough that speculators will continue buying them on a regular basis.  But I digress.. the principle of a Call option can be extended to all aspects of life especially if we don’t restrict the payoff of the Option to money or financial assets.  If you’ve even been in a situation where you felt you had a lot to gain and a little to lose, that’s essentially a non-financial Call option!

Free Call Options

Virtually nothing in life is “Free” since the pursuit of any activity will cost Time and likely one or more of your assets in life even if it doesn’t cost any money.  (Free beer still takes time to consume and enjoy not to mention the side effects of drunkenness and possibly a hangover.)  So let’s define a “Free Call Option” as any opportunity in life where the downside is relatively limited and the cost of taking the opportunity is also relatively small but there’s a tiny (usually less than 1%) probability that it could pay off HUGE.  And the payoff may be a sum of money or something else that’s equally valuable.

Here are several examples of Free (or cheap) Call Options.  Most arise in social or business situations which involve more complex and non-deterministic dynamics than, say, physics.

1. Meeting influential people at a party or conference.
2. Reaching out to dozens of networking contacts, recruiters, and job postings when searching for a job.
3. Advertising your blog, eBook, product, etc. online by posting to dozens of targeted forums, social networks, blog comments, etc. (without being spammy of course.)
4. A salesperson pitching a new product to a long list of warm contacts.
5. An entrepreneur designs a dozen product prototypes and tests them out with prospective customers for interest and feedback instead of investing a ton of time and money building a single fully functional product hoping people will buy.

So what do the above examples have in common?

1. A low probability of success for each endeavor.
2. A potentially high payoff in the event of success.
3. A limited cost for undertaking the endeavor and limited downside in case of failure (assuming you don’t do anything stupid.)

The Free Option mentality for tacking life’s goals will generally lead to greater prosperity in the long run as long as:

1. “Free” (or cheap) options are correctly identified.
2. Free options are pursued en masse and on a regular basis (since each endeavor’s probability for success is low but doesn’t cost you much in the first place either.)
3. You have a propensity to delay gratification and not to be discouraged by failure.

For a more in-depth discussion of using Financial Options to model the disproportionate payoffs from life’s events, please check out Nassim Taleb’s book “Antifragile“.