Options
The future is uncertain, yet the decisions we make today can greatly affect our ability to succeed in the future. This is why options and optionality play a crucial role in decision making. Possessing an option provides the ability or right, but not the obligation, to take an alternative course of action.
At Koch, we encourage everyone to understand what options are available and the benefits, costs and risks of each. To determine whether acquiring, granting or building an option would be profitable, we need to apply marginal analysis in estimating whether its future risk-adjusted value would be greater than its cost.
There are three types of options: exchange, contractual and operational.
Those traded on an exchange – such as puts, calls and swaps for stocks and commodities – are regularly used by employees involved in trading or risk optimization.
Contractual options are much more widely used, varied and nuanced. They involve negotiations with counterparties and are embedded in contracts. Examples include:
- In a sale or purchase agreement, the right to change (within a range) the duration, volume, specifications or other terms.
- The ability to sell an investment or other asset when most beneficial.
- On long-term contracts, the right to extend or exit early.
- When investing in another company, the right to increase participation or control, or convert the asset from one form to another: equity, preferred equity, debt, other.
- The right of first refusal (ROFR) or right of first offer (ROFO).
- Getting profit participation when selling an asset that might become more valuable than anticipated.
When we grant or sell a contractual option, it is most important that we limit our obligations to avoid a disastrous loss, even if we believe the probability is low. This includes ensuring the document is clear, reflects the commercial agreement and does not grant implicit or unintended options. It is also important to recognize that:
- Options we provide to customers in contracts on volume, quality, type of products or duration can be very expensive, so we need to be fully compensated for the risk.
- Giving ROFR, ROFO or other last-look options can chill bidders and significantly reduce the market value of an asset, and need to be limited.
- When counterparties have the option to cash us out of an investment early, we need to structure it to ensure we still have a sufficient return.
- Granting someone an option to buy a Koch asset prevents us from selling it to others during the term of the option. Thus, we need to keep the term short
Operational optionality creates flexibility in an asset or organization. Examples include:
- Building assets so they can be expanded efficiently, produce different products or use a variety of feedstocks, energy or other inputs.
- Having the ability and the right to change the organization’s structure and optimize people’s roles as conditions change.
- When selling a collection of assets, keeping those that are not valuable to the buyer but may be to others.
- Innovating to create different products or ways of doing things.
All of us need to seek profitable opportunities to acquire, sell and build options that can create significant value for Koch. It is an important way we differentiate ourselves and critical to our long-term success.