Optionality in Sports
Optionality is a powerful concept and mental model for decision-making; while it’s often used in investing and venture capital, its applications are truly endless as it provides a valuable framework for maximizing gains while minimizing losses. Today’s article focuses on how this framework underpins the decisions made inside the front offices of sports teams, and how organizations who maximize optionality often see the best long-term results.
But before diving into the applications of optionality, it’s important to gain a concrete understanding of what the concept is. As the great Nassim Nicholas Taleb explains it, “Optionality is the property of asymmetric upside (preferably unlimited) with correspondingly limited downside (preferably tiny).” This phenomenon is very key in venture capital: when a firm makes an investment in an early stage startup, the potential downside (if the company fails) is however much they invested in the company. But if the startup succeeds and eventually reaches an exit (either acquisition or IPO), the upside is several orders of magnitude higher than what the downside would’ve been. It’s not the batting average that matters, but rather betting on the home runs which return the fund.
Mathematically, optionality boils down to decisions which create 1x downside but 100x upside. You can swing for the fences and strike out nine times out of ten, but one time you hit the ball will lead to overall returns which are net positive. It builds on the expected value concept from statistics: when multiplying the magnitude of possible outcomes by the probability of those outcomes occurring, the sum of those products generate the predicted value of an event or decision. If you have a 90% probability of losing 1x (1x downside), but a 10% probability of winning 100x (100x upside), you still have an expected value of 9.1x. That’s a decision you’d take every time; even if the odds are stacked against you, the asymmetric outcome distribution still optimizes for high expected returns.
In order to truly leverage optionality, one has to be contrarian and have a differentiated perspective. It’s only when you can see an ocean of value where others aren’t even looking that you can find non-obvious upside with low-risk, high-reward opportunities. If the upside is obvious, especially in the short-term, everyone can recognize it’s value and the demand will be high, leading to a higher cost of that value (and more risk associated with it). It’s like in sports, when a star player wants out of their team and goes on the trade market: everyone knows the immediate upside of acquiring that player on their team, and thus the price for making the trade is high (teams often have to give up their treasure chest of assets). While a best-case scenario generates high returns in the short-term, a worst-case scenario leads to losses of a similar magnitude because of how much the team put on the line when making that acquisition. These big short-term bets gut the team of flexibility; if the move fails, it puts the team in a position of being stuck because of how they put a substantial proportion of their resources in this one bet.
Having a long-term outlook, on the other hand, is a contrarian approach which exploits inefficiencies in a market with an irrational bias towards short-term gains. In sports, teams are wired to make moves which amplify their chances to win in the immediate present, often to please ownership and maintain fan excitement. Conversely, aiming for long-term upside maintains optionality because the cost of that value is lower, as fewer people are thinking ahead enough to recognize that future upside. As Sam Hinkie (former GM of the Philadelphia 76ers and currently the founder of the venture firm 87 Capital) has said: “to take the long view has an unintuitive advantage built in — fewer competitors.”
In fact, Hinkie’s approach when running the 76ers was one predicated on taking the long view, which leveraged the power of optionality because of how myopic rival teams were in that time period. When Hinkie took the reins of the 76ers in 2013, he knew that the only way he could turn the team into a contender was by building a team with superstars. From his deep study of NBA history, he knew that great players were a power law — the best ones can change everything. If a large part of winning championships (or contending for them) is having one of these top players on your team, the question shifts to how do you acquire them? Hinkie identified three primary levers for acquiring star talent: free agency, trades, and the draft. But, as the 76ers were a mediocre team at the time, he saw the odds of landing star talent from a free agency signing or a trade fairly low. The team currently didn’t have the winning track record and the lure to attract star players in free agency, and they didn’t have enough trade assets to make a big swing when a star came on the trade market.
Building through the draft, on the other hand, was a lever which they could pull to build a title contender in the long-term. In the short-term, young players in their first few years in the NBA can rarely perform well enough to compete against the top teams, as their early years are full of ebbs and flows. But as these young players develop and grow, their long-term value and upside can be immensely high. This was Hinkie’s edge: while other NBA GMs were thinking a few years out, he was thinking a decade out, focusing more on what players could be tomorrow (or in years) than what they were today.
Another bug (or a feature) of the NBA draft is how inherently random and uncertain it is. Teams get it wrong far more often than they get it right, in large part due to the difficulty of accurately predicting how a 19-year old kid will evolve in the NBA amidst a sea of new circumstances. The combination of this uncertainty and low short-term impact of draft picks made their market value fairly low, especially at that time. For Hinkie, this was the market inefficiency which he was going to exploit. Being one of the early contributors to the NBA’s analytics movement, he knew how statistically unpredictable the NBA draft was; he countered this by accumulating as many draft picks as possible to maximize his likelihood of striking gold. As he had said himself (at the time): “I want as many swings at the plate as I can get. We will not bat a thousand on every single draft pick. We also have them by the bushelful, in part, because of that.”
Draft picks are high-optionality assets. The downside of getting a pick wrong is simply the market value (which was fairly low in 2013) of the pick, or what the pick could net the team in trade value. (It’s important to note that the downside of getting a pick wrong is not the opportunity cost of not selecting the next best player available, because it’s impossible to forecast how another player would have performed in different circumstances. For example, when the Detroit Pistons selected Darko Miličić with the #2 pick in the 2003 NBA draft and passed on future stars like Carmelo Anthony, Dwyane Wade, and Chris Bosh, the downside of the Darko pick wasn’t the value of any of the three players they passed on because it’s impossible to predict how any one of these three stars would have performed in a Pistons uniform. Rather, the downside of the Darko pick was the market value of that year’s #2 draft pick, which may have still been fairly high because of how talented that year’s draft was in comparison to other drafts.) The long-term upside of getting the pick right, on the contrary, is landing a player who could catapult the franchise to new heights and lead them for years to come. The first few years of development might be rough and may keep the team in a losing position in the short-term; but when the upside reveals itself down the road, it could be the transformational gem which finally brings the team over the hump and gets them a championship.
Hinkie knew this, and made it his goal to acquire as many draft picks as possible, even if that meant trading players who were decent immediate contributors for the team. He did have his fair share of misses, examples of high-optionality decisions which can go the wrong way. But, just as is true for any venture investor, it’s the makes and the home runs which matter far more, and having more swings at the plate and an abundance of picks maximize that probability of hitting the ball out of the park. For Hinkie, his home run was Joel Embiid, the player he drafted with the 3rd pick in the 2014 NBA draft. There was heavy organizational resistance within the 76ers towards drafting Embiid, largely because he had suffered an injury in the college basketball season which made it likely that he’d miss his entire rookie year. But Hinkie, thinking long-term, saw something special and generational in Embiid. He looked like the second-coming of Hakeem Olajuwon with his dominance and skill in the post, could be an anchor on the defensive end with his shot-blocking ability (largely thanks to his 7-foot-5 wingspan), and was described by his college coach Bill Self (from the University of Kansas, a basketball powerhouse) as a sponge who grew faster than any player he had previously coached. Even though Embiid’s injury would keep him out for the upcoming 2014–15 season and not give the team the immediate injection of talent which many though they needed, Hinkie knew that Embiid was the one player in the draft who could evolve into a franchise centerpiece for the 76ers. Seven years after Hinkie drafted him, Embiid finished 2nd in NBA MVP voting (for the 2020–21 season) and led the 76ers to the best record in the Eastern Conference. Taking the long view worked: with Embiid at the helm, the 76ers are a surefire title contender.
Another team who leveraged the high-optionality nature of draft picks to build a contending team is the Boston Celtics. The Celtics won the NBA championship in 2008 with a core of tremendous players, led by their “Big 3” of Paul Pierce, Kevin Garnett, and Ray Allen. These three had phenomenal individual careers before teaming up on the Celtics, and were able to come together (thanks to an array of wizard moves by Boston GM Danny Ainge) to achieve the elusive goal of winning an NBA title. But at the time of this 2008 title run, the players were nearing the end of the window which was their peak: Pierce was 31, Garnett was 32, and Allen was 33. Though they’d make the NBA finals once again in 2010 and push the Lakers to a seven-game series, a regression after that was sure to come. Though the collective grit and tenacity of the Celtics and the rise of point guard Rajon Rondo would keep the team in the title hunt for a few more years, the decline of their three superstars (largely due to age) was obvious. No season would reveal this more than the 2012–13 one: after Allen left the team in free agency to join the Miami Heat, the trio of Garnett, Pierce, and a newly added Jason Terry would combine to finish with the 7th seed in the Eastern Conference, the worst Celtics season since before the Big 3. Whether fans would want to admit it or not, this era in Celtics history was coming to a close.
Nobody would be able to predict what happened next: on June 28, 2013, the Celtics traded Pierce, Garnett, Terry, and role player D.J. White to the Brooklyn Nets for:
- Brooklyn’s first-round draft picks in 2014, 2016, 2018
- The right to swap first-round draft picks in 2017
- Kris Humphries, Gerald Wallace, MarShon Brooks, Kris Joseph, and Keith Bogans (just to match salary)
This trade was a decision of high-optionality for the Celtics. The downside of the move, equivalent to the value of the players they were giving up, was very low: Pierce was 36, Garnett 37, and Terry was 36. The Celtics had squeezed all they could out these three aging stars, and it was clear that the value they could bring to the team was nowhere close to where it used to be. While the players Brooklyn sent in the trade were solely for salary-matching purposes, the real crown jewels of the trade were the four (including the 2017 pick swap) first-round draft picks. In a worst-case scenario for the Celtics, Brooklyn would somehow utilize the talent of Deron Williams and Joe Johnson to become a title-contender, and those draft picks from the Nets would land somewhere in the late first-round (#25-#30 range). Even if this worst-case scenario did play out, the downside would still be low because of how little they gave up in the trade. But instead, to the joy of Celtics fans, the best-case scenario would come to fruition: the Nets’ experiment with these aging stars would go belly-up, and by 2016 they saw themselves at the absolute bottom of the NBA. Their first round draft picks, which belonged to Boston, ended up being the #3 pick in the 2016 draft, the #1 pick in the 2017 draft (which the Celtics traded to Philadelphia for the #3 pick and future assets), and the #8 pick in the 2018 draft (which the Celtics traded in the 2017 offseason for Cleveland Cavaliers superstar Kyrie Irving). In a decision where the downside was 1x, the Celtics saw an upside several orders of magnitude higher reveal itself down the road. Boston used the #3 pick in the 2016 draft to select Jaylen Brown, and they used the #3 pick in the 2017 draft to select Jayson Tatum. Brown and Tatum are both all-stars, and are valuable cornerstones for the Celtics to continue building around. This high reward situation which the Celtics are in right now manifested itself through a decision which offered little risk or downside, demonstrating the power of optionality.
While the draft can offer many opportunities of optionality, it isn’t the only area of asymmetric upside. Remember, the fundamental source of optionality is contrarian thinking and seeing an ocean of value where others aren’t even looking. As Peter Thiel likes to ask whenever he interviews candidates for a job, “What important truth do very few people agree with you on?” When teams come across a non-obvious truth or insight about a player or pattern, they are able to treat it as a secret which only they know. When teams know a secret about the game, they’re able to leverage it to get more with less; they can push less of their chips to the middle but still win the table.
One secret which the Golden State Warriors knew in 2012 was that Stephen Curry had very high upside. It was a contrarian viewpoint at the time, in large part due to Curry’s recent history of ankle injuries. He had shown flashes of being a prolific shooter, but nothing in his first three NBA seasons showed clear signs of a generational talent who’d change the game of basketball. That’s why, when Warriors GM Bob Myers was asked at his 2015 NBA Executive of the Year award ceremony about a big risk which paid off, he proceeded to talk about signing Curry to a 4-year contract extension in 2012, given the doubts surrounding his health and trajectory. But in reality, the contract extension ($44 million over 4 years) posed little risk at all. Curry was getting paid around $11 million a year (this was his market value, with demand being low because of his injury history); during the first year of his contract extension (2013–14), this was less than what Tiago Splitter, Gerald Wallace, and Danilo Gallinari were being paid. By the final year of this extension (2016–17), Curry was making less money per year than JR Smith and Ian Mahinmi. Given the contracts which players were signing on the time, the bet which the Warriors made on Curry was a relatively small one. For free agent signings, the downside of signing one player to a contract is the value which that same amount of money could garner on the free agent market. As mentioned above, the caliber of players signing contracts of roughly $11 million per year were fairly low, showing a low opportunity cost and downside for the Curry contract extension. This was a low-risk, high-reward play for the Warriors, and Curry’s complete recovery and marvelous dedication to his craft would ensure that his incredibly high potential would be realized.
As Taleb once said, “Optionality can be found everywhere if you know how to look.” From investing to venture to sports and virtually any field with an importance on decision-making under risk, situations of asymmetric upside are a powerful way to minimize risk and maximize reward. What’s needed is contrarian thinking and the ability to leverage that to find the signals amidst market noise, and act on them when high-optionality opportunities arise.
