Optionality is an idea advanced by Nassim Taleb in his book Antifragile.
At the most basic level, optionality just means having lots of options.
If you develop a skill with many possible job opportunities, you have more optionality than someone who develops a skill that only has one or two job opportunities.
The advantage of optionality is that as the world grows increasingly difficult to predict, you can thrive in spite of not knowing the future.
You simply see what happens and exercise whichever option turns out to be most advantageous.
In Taleb’s words:
“Options, any options, by allowing you more upside than downside, are vectors of antifragility.
If you “have optionality,” you don’t have much need for what is commonly called intelligence, knowledge, insight, skills, and these complicated things that take place in our brain cells. For you don’t have to be right that often. All you need is the wisdom to not do unintelligent things to hurt yourself (some acts of omission) and recognize favorable outcomes when they occur. (The key is that your assessment doesn’t need to be made beforehand, only after the outcome.)
Option = asymmetry + rationality
The mechanism of optionlike trial and error (the fail-fast model), a.k.a. convex tinkering. Low-cost mistakes, with known maximum losses, and large potential payoff (unbounded). A central feature of positive Black Swans.”
Central to optionality is Taleb’s assertion that prediction in the modern world is impossible. Instead of trying to predict what is going to happen, position yourself in such a way that you have optionality.
That way whatever happens, all you have to do is evaluate it once you have all the information and make a rational decision.
What Qualifies as an Option?
In order for something to qualify as an option, it must be convex. That is, it must have limited downside with large, open-ended upside.
Taleb began his career trading financial options where a trader pays a small amount of money to have the option to buy a stock at a future price. If the stock price soars or plummets, the trader can exercise the option and make a large profit. If it doesn’t, the trader loses only the small amount he paid for options. It has a payout profile with large upside, but small downside.
Someone who starts a small side business on the weekends with a couple hundred dollars is generating optionality. If the business fails, they’ve only lost a small amount of start-up capital. If it takes off, it could replace the income from their job.
Concavity is the opposite of convexity. It means you have large potential downsides with small potential upside. You are picking up pennies in front of bulldozers. If you’re right you gain a little, but if you are wrong then you lose a lot.
This graph illustrates Taleb’s concepts of convexity and concavity as they relate to antifragility.
The top half is convex: small potential for pain with a large potential for gain. The bottom half is concave: a large potential for pain with only a small possible gain.
Why Does Optionality Matter?
If you start from the premise that we are living in an uncertain world, then optionality is the only way to outperform the average in the long run.
The more uncertainty, the more role for optionality, and the more you will outperform the average.
The other issue is that options expire so you have to be generating options at an ever-increasing velocity.
Consider a sales pipeline as an analogy. If you aren’t constantly generating new leads, existing leads go cold. You have fewer options and less leverage to negotiate. You may feel beholden to existing clients or customers despite cash flow being better than it ever has been.
The famous copywriter Dan Kennedy always spent the first hour of everyday on sales activities even if he had more customers than he could possibly fulfill for.
It allowed him to maintain a sense of freedom and wealth because he always had more opportunities than he could say yes to. He wasn’t keeping his pipeline full, he was keeping it overflowing.
Because options expire, you want to be cashing in some (closing the sale in this analogy) and generating new ones.
How do we increase our optionality?
Sticking with our sales pipeline analogy, our salesman has certain assets or currencies – his sales ability, the quality of the product he’s selling, the relationships he can leverage, his health and energy to make sales calls.
So how does he increase the number of options available to him?
The key to optionality is to focus on the fat tails. Let’s say you have $500 to spend to help grow your business. What’s a better investment: would you spend it on pay-per-click ads driving everyone to your products, or buying a group of people in your industry dinner?
Taking people out to dinner is a higher optionality move. You spend $500, someone introduces you to a friend who eventually becomes your business partner, and you sell the company for $10 million dollars five years later. Is this unlikely? Yes, absolutely. But the purpose of optionality is that if you systematically pursue options that are unlikely but have huge potential pay outs then you only need one or two to make it worth it.
Any asset – skills, time, cash, health or relationships can all be used to create more optionality. When you learn a new skill, say website design, you suddenly have the ability to do things you couldn’t before. For most people developing their professional skills and professional network is the easiest way to increase their optionality.
When you have a valuable and diverse skillset and a large professional network that knows, likes, and trusts you then you are going to have a lot of options. These options could manifest as new job opportunities, starting a company, or changing careers.
Last Updated on November 16, 2022 by Taylor Pearson