Travis is my first new contributor to the blog, who will be writing a post every Wednesday to start. The idea behind adding guest contributors is to add different perspectives to the blog. Travis has a unique approach towards travel, given that he travels almost exclusively with his wife and young children, which is in stark contrast to my travels, which are usually alone.
By now I’m sure that everyone and their Grandma has heard about the upcoming devaluation to the British Airways Executive Club program, so I won’t recap it here.
Instead, I want to discuss the optionality of miles and points programs, particularly flexible points currencies such as American Express Membership Rewards, Chase Ultimate Rewards, or Starwood Preferred Guest points. These currencies have inherent “transfer options” built into them, meaning that you always have the option to transfer them to other miles and points programs, sometimes with a bonus. As a result, these programs have a degree of optionality implicit in their programs, meaning that you are presented with a choice, perhaps one you weren’t expecting.
For roughly the past six weeks, the US American Express Membership Rewards program has had a promotion running whereby you receive a 40% bonus when transferring points to Avios. It’s the largest transfer bonus in several years and it’s set to expire on Jan 31, 2015, only a few days from now.
Therefore all of us with Membership Rewards points implicitly hold options that entitle us to convert 1000 Membership Rewards points to 1400 Avios. We can choose to redeem these options, or we can choose to let them expire. (Sadly, we can no longer easily “trade” them to someone else since American Express only allows points transfers to authorized users on the account.)
In this post, I will discuss how we can apply options theory to thinking about transfer bonuses. I realize that this is pretty dense stuff — trust me, there were times when I flat out fell asleep during my quantitative finance classes! But after a while, I realized that it’s a pretty darn cool way to think about a lot of things. So if you can stick with me for a bit, maybe it’ll make sense by the end.
Now who’s ready to Geek-out with me?
How Stock Options Work
In the stock market, a call option gives you the right to buy the underlying stock at a given price (the strike price) by the expiration date. You can choose to exercise the call option at any time, but you have to exercise it (or sell it to someone who will) by the expiration date, else it becomes worthless.
There’s a saying in finance that an option is worth more alive than dead. Here’s why.
Consider a stock that trades at $100. You hold a call option with a strike price of $75 and an expiration of Jan 31. Exercising the option means that you get to pay $75 to buy something that is worth $100 today. Sounds pretty good, right?
The problem is that you don’t know what could happen between now and Jan 31. If the company declares bankruptcy tomorrow, the stock could crash and be worth $10. You would lose $65 immediately (the difference between what you paid for the stock, and the price it’s now worth.) Had you not exercised early, you’d still be holding the option after the company failed, rather than the stock itself. In this case your option would be worthless, but you’d still have $75 in your pocket.
The key here is that there’s no benefit to exercising the option early. Holding the option instead of the underlying stock gives us downside protection — the worst that can happen is that our option expires and becomes worthless. Once we exercise the option, we end up with a share of stock, and are now completely exposed to any downside movement of its price.
We should therefore want to hold the option as long as possible such that we can “wait and see” what happens with the stock for as long as possible before committing to it. That’s why the option is worth more alive than dead.
A Transfer Bonus Is Like A Stock Option
I hope you can see the parallels between this example and the Amex to Avios transfer bonus. There was really no benefit to exercising the option to transfer points early, as it just opened up the possibility of suffering a major devaluation in the underlying Avios currency. (The lone exception would be if you were planning to redeem an award immediately, but that also eliminates your exposure to Avios devaluations.)
By continuing to hold the Membership Rewards points and the transfer bonus options, you could maintain liquidity and flexibility – if British Airways devalued their program, you could choose to let your transfer bonus options expire unused and instead transfer to Aeroplan, Singapore, or any of the other programs at some point in the future.
Here are the takeaways:
- Don’t exercise your transfer options early.
- Hold points in flexible currencies like Membership Rewards, Starwood Preferred Guest, or Chase Ultimate Rewards until the last possible minute, either when
- You are ready to book an award
- A transfer bonus is set to expire.
- I recommend setting a calendar alert so you don’t forget. Procrastination can be good, outright forgetting is bad.
My Transfer Bonus Option Plan
All that said, this devaluation doesn’t seem so bad for my particular Avios redemption patterns. I’ve gotten good value from the short-haul awards lately, particularly in economy where not much appears to be changing. I don’t think I have credited a flight to British Airways in over a decade, so nothing is changing there for me either. The one award that I was moderately interested in redeeming in the near future which will no longer be possible is the east coast to Ireland in business for 50,000 Avios.
So overall, maybe this is not so bad, especially if it means that we’ll be spared further devaluations for a while.
And in the current climate of devaluations, “not so bad” is the new good!
I plan to proceed with exercising my transfer bonus option in a sizable quantity, likely around six figures. Ironically, this devaluation actually makes me more confident in that decision since this devaluation was significant enough such that I expect the British Airways program to be stable for a while.
I mean, only Delta announces a devaluation, and then devalues again before that devaluation even takes effect, right?
Who else was waiting until the last minute to exercise their transfer bonus option? Did you actually think a British Airways devaluation could be coming?Or were you just procrastinating like me and got lucky?
Either way, you can now tell your spouse and friends how smart you were. Just don’t quit your day job to become an options trader quite yet.