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Hyundai puts

I hope we all recognize that options are commonly used in our daily lives, but Philip brought a new one to our attention. The Hyundai put. He writes an anonymous blog: Weakonomics

In turn he got this story from Edmunds.

Because depreciation is the single most important cost factor in owning an automobile, this program is designed to ease concerns when buying a new car. Says company CEO John Krafcik, “While Hyundai’s depreciation is now among the lowest in the industry, Assurance will remove many of the barriers and concerns about vehicle ownership.”

The Details

Hyundai will guarantee the trade-in value for its vehicles, an unusual move said to be a first for any automaker.

The Hyundai Assurance Trade-in Value Guarantee provides owners with a guaranteed value for their car in months 24 through 48 of ownership.

This appears to be an attractive offer with no negative aspects. But we know better than that, don’t we?

When you trade in the car, you are guaranteed a minimum selling price for that car. Thus, it’s a put option, which by definition, allows its owner to sell the underlying asset at the strike price before the option expires.

The fine print

The fine print shows that this company plays fast and loose with the term ‘guarantee.’ Here’s one definition that I found at an online dictionary:

An unconditional commitment that something will happen or that something is true

The conditions
  • The deal only applies to the purchase of another Hyundai. (Reasonable)
  • The car must be serviced at a dealer.
    • As we know, that’s paying top dollar for service.
    • How much will that cost the average car owner?
  • Does this apply to any Hyundai, in any condition? (No chance)
    • “the customer will receive the guaranteed trade-in value amount, less any applicable mileage charges or damage costs.”
      • Drive too much? The strike price declines
      • Have dents or scratches? The ‘guaranteed’ price disappears

This put is a bit different from our puts in that the ‘expiration’ window extends over a period of two years, and is not a single day.

It is not going to be easy to estimate the value of this put option.

Here’s an interesting statement taken from the company’s website:

Purchasing a new vehicle is one of life’s big events. You want to know everything you can about the true value of your options

I’m sure it was unintentional, but they are correct. We want to know the value of our put option.

At the time of purchase, it is almost impossible to know the future trade-in value of the vehicle. I’m certain that Hyundai is not going to err on the side of making the strike price too high.

So what’s the big deal?

Why write about this put option? To me, this is a very interesting story. Under normal conditions the buyer of a put option pays a premium to the seller. Thus, the car buyer must be alert to the possibility that they are being overcharged for the put. There are many financial products offered by banks (you know, those nationally based businesses with no integrity, no compassion, and filled with CEOs whose hearts are blacker than coal) in which there is an embedded put option. Those products are far too complicated for the average investor to understand, and as a consequence, are priced higher than they are worth. More profit for the banks.

So, if you buy one of these cars, be certain to get the price with and without that put option. There is a chance you would be paying far more than the put is worth. That becomes a real problem when that protected trade-in value (strike price) is low.

There is another side to this story, the psychology factor. Do not underestimate the value of this aspect.

Because owners are getting something of perceived value, it’s likely they will not want to discard that put option by allowing it to expire worthless – unless it is truly out of the money. That would occur if the specified strike price (designated trade-in value) were lower than the car’s true value at the time of trade in. But what happens if that strike price is set low? I know they claim that a true effort will be made to estimate the trade-in value accurately,but we know that there is no advantage to selling options at their fair value. These guys want an edge, and perhaps that edge lies in the psychological factors. Perhaps there will be a perceived value in exercising these puts (when there is no real value) with the purchase of a new car.

If that’s the scenario, then Hyundai should be paying customers for accepting the ‘gift’ of a free put. That put option appears to be of value to the company by helping to sell cars. But for the car owner, it’s almost worthless. That makes me ask: What is this ‘free’ benefit for the customer worth to Hyundai? How many cars are going to be sold because this ‘deal’ sounds so good? And how many cars will be sold in the future because people hate to see their options expire worthless. This is a public relations triumph for the company and a trap for the consumer.

I find this to be a fascinating topic and perhaps some individual investors who are not already familiar with options will be interested in learning more.

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