On Opt-Outs and Risk Mitigation

On Tuesday, David Price signed the largest contract for a pitcher in baseball history, getting $217 million over seven years to join the Red Sox. But the value of his deal isn’t just the $217 million dollars he’s now guaranteed; he also obtained an opt-out which gives him the right to hit the free agent market again in three years, if he believes he’ll be able to get a raise at that point. If he pitches well over the next few seasons and opt-outs, he may very well be able to replace the final $127 million of this deal with another $175 to $200 million commitment, pushing the total he’d collect between the two contracts close to $300 million.

Yesterday, Eno Sarris looked at the opt-out from a few different angles, estimating that it added something like $10 to $15 million in value to Price’s deal. Clearly, the opt-out is a perk to the player, as it allows them to reset their salaries if they play well and the market inflates, but doesn’t give the team the same option if they struggle or get injured. The team assumes the full risk of the guaranteed money, but does not get the same potential return if the investment goes well, as the opt-out reduces the upside for the team.

But could an opt-out clause also reduce a team’s risk? Over the last few days, both on Twitter and in (and after) my chat yesterday, a significant number of people have argued that including the opt-out increases the odds that the Red Sox avoid the riskiest years of this deal, and that the opt-out could help the team if they’re willing to let him leave after he opts out. After all, at that point, they’d have signed the best pitcher on the market for $90 million over three years, which is obviously a pretty great outcome for the team.

This assertion often conflates correlation and causation, though. While it’s true that getting three years of Price at $90 million without carrying the longer-term risk is a good outcome for the Red Sox, Price only opts out in situations where his market value is greater than the remaining $127 million left on his contract. In other words, at that point, the Red Sox wouldn’t be able to replace Price’s expected future performance by spending $127 million; they’d either have to pay more to keep him in Boston, or pay a lesser player (or players) that amount in order to fill the hole that the opt-out created. The opt-out occurs at a point when the original contract has turned out well for the Red Sox, but the opt-out is not the cause of the contract turning out well, and it does not improve the team’s situation at the point the opt-out is exercised.

From a purely accounting standpoint, the only way including an opt-out can be a positive for the team is if the player takes a larger discount in guaranteed money than the value of the opt-out is expected to provide. For instance, if Price would have demanded $250 million without the opt-out, then signing him for $217 million and including an opt-out is very likely a better decision for the Red Sox, since the math suggests the value of the opt-out is less than $33 million. For a team, whether to include an opt-out should mostly be a calculation based on the difference in guaranteed money the player is willing to leave on the table in order to have the opt-out included.

But while I’ll disagree with the sentiment that including the opt-out without getting a financial offset can ever be a net positive for a team, I do think a few interesting counterpoints were raised about the difference in expected long-term outcomes for a team when an opt-out is included. In particular, this comment from Josh yesterday explained a somewhat different perspective pretty well.

Certainly, if Price opts out, it’s because there’s a market for his services that may or may not include the Red Sox. In theory, if he had positive value, the Red Sox could trade him to one of those other teams interested in picking up the back end of his deal, no doubt.

The problem is that the market doesn’t work that perfectly. There are relatively few teams that can absorb a $32M pitcher and it’s possible that they are undesirable trade partners (division rivals, poor relationship between front offices, etc). If there is a trade partner, there’s no guarantee that the available return is greater than the value of a qualifying offer. There’s also a chance teams would be less than excited to acquire an asset at full price that’s only being dealt because of the risk he’s about to decline. If he opted out, it’s likely more teams would get involved at a sub-32M AAV in exchange for years. Perhaps he’d take 6/150 rather than 4/128.

I tend to think along the same lines as Dave on this — that the opt out is obviously player friendly — but the argument that there is no conceivable benefit to the team is a little too black and white for me. They definitely won’t be able to acquire a package of players from an interested trade partner this way(versus “might have been able, otherwise) but I’m sure the Red Sox would get over the grief of being out from under pricy decline years and their newfound payroll flexibility and draft pick quickly enough.

In the scenario where Price opts out, it is a given that there’s a market for his services that would result in a larger payday awaiting him in some other city. I’m not particularly convinced by the annual average value argument, as if a team was willing to pay him 6/$150M, they’d likely be willing to trade for Price at 4/$127M and then sign him to an extension that pushed some of the present money back into the new years of the deal; Price doesn’t have to be a free agent for an acquiring team to re-work his contract, after all, and plenty of trades are made contingent upon a player agreeing to a contract with their new team as part of the deal.

But I think Josh raises a point about the potential frictional costs of making a deal that are worth considering. In the scenario where Price has positive value in three years, he’s clearly pitched well to that point, and teams are often reluctant to trade star players who are performing at a high level, even if you could argue that there are signs that point to it being a rational decision in order to do so. The opt-out could force a rational decision upon the Red Sox where irrationality would prevail otherwise. While a team owning a positive-value contract without an opt-out always has the option of essentially forcing an a similar outcome if they so choose — MLB has the waiver system, and any player claimed on waivers could always be given away at any point, so a team is never really stuck with a long-term contract that has positive value relative to the market rate — often contracts at this valuation come with no-trade clauses, which complicates the ease of making a trade, even if a team decided they wanted to do so.

There are frictional costs to trying to trade highly paid star players, and regularly, teams end up hanging onto expensive aging players beyond their sell-by date because of the perception backlash that comes with trading a face-of-the-franchise type of talent. So, perhaps the theoretical upside of the potential trade value is overstated, if a team isn’t willing to act on that trade value. And the point about the qualifying offer is completely correct; even though a team doesn’t get to trade a player who opted out, in the current form, they are compensated with an asset valued at roughly $10 million in exchange for the player leaving for another organization.

We don’t know that the qualifying offer system will survive the next round of CBA negotiations, so a team signing a player to a deal with an opt-out this winter shouldn’t count on the fact that they will get draft pick compensation if the player outs out, but it is a potential benefit that could be realized by a team that has a star player opt-out in the future. The draft pick isn’t going to wholly compensate a team for the entirety of a player’s positive trade value in most cases, but we shouldn’t also assume that a team who has a player opt-out gets nothing in return; it’s the marginal gap between the potential crop of prospects and the draft pick that matters.

But beyond that, the increased likelihood of the team’s ability to walk away from an extension versus choosing to trade the final years of a deal also have to be factored in. And when we look at how irregularly teams choose to trade these types of players, it’s a fair point to suggest that the opt-out may force them into a good decision more frequently.

Overall, the opt-out is still always going to be a player-friendly perk, and one that benefits the player more than it benefits the team. But given the frictional costs involved with actualizing the trade value of a star player versus receiving compensation if the player forces the team into walking away from the risk of the longer-term commitment, the marginal cost of an opt-out to a team may be diminished somewhat. And if a team can get a player to leave $15 or $20 million in guaranteed money on the table — especially by taking a lower annual salary up front, and pushing more of their compensation to the end of the deal, after the opt-out decision has to be made — in order to obtain the opt-out, then it can be a perfectly rational decision to include one in a contract.





Dave is the Managing Editor of FanGraphs.

newest oldest most voted
Ben
Guest
Ben

There’s another option that makes an opt-out valuable for a team. Price pitches well, opts out, signs with another team, and then gets injured or becomes ineffective.
The operating assumption for many saying the opt-out is only good for player is that if Price is good and exercises his opt-out, that he will continue being good for the subsequent 4 four years.

Imagine if Roy Halladay had a clause that let him opt out after his 2011 season. He opts out, signs with another team, signs for crazy bucks after putting up a 9 WAR season, and we all know what happens next. For reference, Price can opt out around the same age Halladay fell off a cliff.

Atreyu Jones
Guest
Atreyu Jones

That’s attributing things to the opt-out that the opt-out didn’t cause though.

That’s like saying that if Jose Bautista was declared a free agent today, it might be valuable for the team because he could get injured and provide no on-field value for the Jays tomorrow, and therefore the Jays would have save $14m.

Ben
Guest
Ben

Nobody is saying the opt out caused those things, it’s just a possible (in fact, probably) outcome that’s not being accounted for.

Atreyu Jones
Guest
Atreyu Jones

But if we are accounting for the opt-out (as this article is doing) why should we account for outcomes that aren’t caused by the opt-out? It’s a different discussion.

You cite the Halladay example, but opposites exist out there. If Hamels had an opt-out and went elsewhere, the Phillies don’t get the trade return they just got. If Pedro had an opt-out and went elsewhere, the Sox probably don’t win the 2004 world series. Etc…

Ben
Guest
Ben

Why shouldn’t we discuss it if it’s not causing it? Hedging risk isn’t strictly about cause and effect, it’s about possible outcomes.

Atreyu Jones
Guest
Atreyu Jones

Sure, we should discuss it. But you said it “makes the opt-out valuable for the team” – that’s implying a relationship that doesn’t exist.

Brian L
Guest
Brian L

That outcome IS being accounted for because the the market value of the player opting out includes risk of injury.

Christian
Guest
Christian

The operating assumption is that if Price exercises his opt out then he’s worth more on the open market than he has remaining on his contract. Even if the Red Sox do not believe that, they could trade him to an organization that does think Price is worth more than his remaining contract.

glenstein
Guest
glenstein

An important distinction: Price is worth more to a market that historically overestimates the value of pitchers in their mid-30s.

The willingness of a team to pay more than is left on the contract doesn’t mean that the Red Sox are hurt by the departure of Price.

They are only “hurt” in that they let him go without using a trade recoup Price’s hypothetical trade value, which, for reasons of friction Dave Cameron describes in the article, may not amount to as much of a loss as people think.

Meanwhile, the Sox get back 4/$127MM to reinvest in something that the market may value more accurately than it does mid 30’s pitchers.

Bip
Member
Member
Bip

If the Red Sox were ahead of the curve when it comes to not overvaluing a pitcher’s mid-30’s seasons, they wouldn’t have signed him a contract that guarantees him over $30 million a year through his age-36 season, that they have pay unless Price himself doesn’t want it. In order for them to “get out” of that commitment, they have to be betting on his early 30’s performance, which, if we continue the beginning premise, means they are overvaluing his early-30’s in order to not overvalue his mid-30’s?

glenstein
Guest
glenstein

The Sox choice to offer 7/212 definitely did not show them to be ahead of the curve. But that’s exactly why an opt-out releasing them from the second half of the contract confers a tangible benefit.

One can certainly make the argument that, since the Red Sox gave price that contract in the first place, they’ll be among the teams ready to irrationally award him a contract in the event he opts out.

But at that point, we’re no longer be debating whether the opt-out afforded the Red Sox with a beneficial opportunity, we’d be debating whether or not the Sox make the most of the opportunity, which is a very different thing and effectively concedes the main point that this entire thread is about.

“In order for them to “get out” of that commitment, they have to be betting on his early 30’s performance, which, if we continue the beginning premise, means they are overvaluing his early-30’s in order to not overvalue his mid-30’s?”

That’s an interesting logical house of cards, but that doesn’t follow. There’s no contradiction in believing Price won’t be as good in his late 30’s as he was in his early 30’s.

Bip
Member
Member
Bip

The Red Sox have no way to get out of it. Price, his agent, and all the teams, know players are worse in their mid-30’s than early-30’s. No one will pay for his mid-30’s expecting exactly what his early-30’s was like. Therefore Price will not “let Boston off the hook” due to some totally naive notion that he should expect his next four years to be exactly the same as his last.

The scenario you’re imagining is nonsense. In order for your logic to work, you have to believe this: Price’s 30-32 is worth the original 3/90. His 33-36 will NOT be worth the remaining 4/127. Despite this mismatch, either Price will foolishly opt out or a team will foolishly sign him to more than 4/127.

jdbolick
Member

I can’t believe this comment received so many minuses. Ben is absolutely correct. No one here would rather have David Price for $217 million over seven years than $90 million over three years, and it’s precisely because we fear what the final four years may look like as he gets older and his arm accumulates even more mileage. Price being dominant for the first three years in no way guarantees that he will continue being worth that money over the next four. So if Price opts out, it has a very significant chance of being a good thing for the Red Sox no matter how good he has been to that point.

Kevin
Guest
Kevin

…buuuuut, if he opts out, the Red Sox are left with nothing but a compensation draft pick. If he was unable to opt out, then the team could choose to trade him.

The entire idea that a depreciating (but still positively valuable) asset being taken away from the Red Sox if that asset doesn’t depreciate quickly is not something the Red Sox would like. As Dave said in his chat ‘if I sold you my car for $10k today, and three years from now repossess it from you, you may have got some good use out of it while you had it, but you probably would prefer to have sold it to someone else. Plus, if the car breaks down after two years, I don’t repossess it, and you have to keep making the payments on it.’

dr. mvn
Guest
dr. mvn

that metaphor might make a fraction of sense if the car is brand new with no mileage. Throw 50,000 miles on it and expect to use it heavily for those three years, and you get out of it without having to take it to get the engine repaired, oil changes, and other remedies that will likely result in getting a reduced return on an increasingly inferior product…yeah, you can have your car back, dude.

Noah Baron
Member
Member

Exactly this. He’s completely right.

I’m amazed at some of the comments that get downvoted to oblivion. Really representative of the declining comment quality here at FanGraphs.

Whether or not you think he’s right, it’s not like he’s trolling; he’s literally just providing a different point of view.

dr. mvn
Guest
dr. mvn

Sabermetrics is dependent on open-mindedness in order for it to be spread and understood further, yet FGs’ comments section is hilariously closed-minded, collectively. It’s quite amazing.

Apocalypse33
Member
Member
Apocalypse33

That’s not my issue with the opt out, the issue is two fold: he basically only opts out if he pitches well, if he doesn’t opt out, there’s a high probability something in the first three years has gone horribly wrong, so you basically are saying, “here, if you pitch well the first 3 years, this is akin to a 3 year deal for you with an option to seek an even bigger payout over the last 4, if you don’t pitch well or get hurt, we guarantee you a lot more money than you’d get on the market for the likely decline years of your career.” This, to me, doesn’t appear rational. Unless the Red Sox really think Price is going to be an Ace for the next 3 years with little to no risk of falling off and are gambling on him to pitch well and opt out.

This brings me to the second issue. If he opts out, the Red Sox will be under both external and internal pressure to bring him back A La Sabathia, which would make those 4 years look far more desirable to what they end up giving him if they do another deal. Granted, this scenario is hardly 100%, but I think the two issues I’ve presented at least illustrate why the opt-out is heavily, heavily player favorable.