What Are Mutual Options, Anyway?

Several years ago, my colleague Mike Axisa, writing for MLB Trade Rumors, noticed a trend. Teams and players had started to use “mutual options” in contracts, in the place of a player option or team option.

Previously, options generally worked one of two ways: With a player option, it’s in the player’s sole discretion whether to stay with the team for the option year at the option price. If the player walks away, he becomes a free agent. With a team option, it’s in the club’s sole discretion whether to keep the player for the option year. If the team exercises the option, the player stays with the team for the option year at the agreed-upon salary. Unless the player has a no-trade clause, the team can trade him once the option is exercised. That’s exactly what the Rays just did with James Shields. If the club declines the  option, then it typically pays the player a certain sum of money, called the buyout.

So what is a mutual option and why is it used?

A mutual option is an agreement by the club and the player that the player will stay with the club for the option year at the option price only if both sides agree. Is that really an agreement, then? Yes. A mutual option is a hedge against volatility in the market for that player in that particular option year. If the player’s value plummets, the team can decline the option and pay the buyout. If the player’s value rises, he can decline the option and seek a better deal as a free agent. If the player’s value is stable, however, then it might be in both parties’ interest to exercise the mutual option.

The market must be volatile, as very few mutual options have been exercised by both sides. In fact, I’ve only identified four fully-exercised mutual options dating back to 2008: (1) the Cubs and Daryl Ward, for $1.2 million for the 2008 season; (2) Miguel Olivo and the Royals, for $2.7 million for the 2009 season; (3) the Astros and Brian Moehler, for $3 million for the 2010 season; and (4) the Rockies and Jason Giambi, for $1 million for the 2012 season. There may be a few more out there that I missed, but I’m betting it’s not many.

On other the hand, there’s a long list of mutual options declined either by the player or the team. Heading into 2013, Adam LaRoche, Sean Burnett, and Ryan Ludwick all walked away from mutual options and into free agency. Burnett turned down a $3.5 million mutual option with the Nationals, and signed instead with the Angels on a two-year deal worth at least $7.5 million, but as much as $13.25 million over three years if certain incentives are met. Ludwick walked away from a $5 million mutual option with the Reds, only to re-sign with Cincinnati for 2 years/$15 million. Adam LaRoche declined his $10 million mutual option with the Nationals, and is still seeking a multi-year deal, either with Washington or elsewhere. LaRoche had previously turned down a mutual option with the Diamondbacks for the 2011 season, before signing with the Nationals. Yorvit Torrealba, Aaron Harang, Jon Garland, Scott Posednick, and Henry Blanco also walked away from mutual options over the last several seasons, seeking greater fortune on the free-agent market.

Many teams have declined mutual options, when players were either too expensive or no longer fit their plans. The A’s inherited a $10 million mutual option in Stephen Drew’s contract when they traded for the shortstop from the Diamondbacks last season. Oakland declined the option, and paid Drew $1.35 million in the buyout. Drew then signed with the Red Sox for 1 year/$9.5 million. When added to the buyout, Drew came out ahead. The Phillies declined a $5.5 million mutual option with Placido Polanco for 2013, and paid him $1 million instead. Aaron Cook, Vladimir Guerrero, Nick Johnson, Russell Branyan, and Erik Bedard, among others, had mutual options declined by their teams in the last few years.

If mutual options are so rarely exercised, why are they used at all?

One reason is to hedge against volatility, as I explained above. Another rationale for mutual options is to conserve on transaction costs down the road. If the player wants to stay with the team, and the team wants to keep the player, the mutual option works like a pre-packaged deal, without the monetary and other costs that come along with off-season negotiations.

And then there’s the deferred money rationale: the buyout, when combined with the player’s yearly salary, sets a floor for what the team will pay the player, but gives the team the flexibility to defer part of its payments to the future. Bear in mind, however, that mutual options are treated like player options under the luxury tax provisions of the Collective Bargaining Agreement. As a result, a team can defer payments to a later year, but the amount of the mutual option buyout will be included in the player’s guaranteed salary when determining the AAV of the contract. To be fair, most teams that are concerned about deferring payments to later years aren’t the ones most concerned with having a payroll above the luxury tax threshold.

If players and teams that are risk-averse, mutual options can make sense. A club may want to keep a player for an extra year, but doesn’t want to give the player the sole power to decide whether to stay or go. A player may like the idea of sticking with a team, but doesn’t want to give the team sole discretion to keep the player if circumstances change.

Mutual options can also be used to defer payments to later years, but not for purposes of the luxury tax. In that way, it’s a club option that acts like a player option. For teams with budgeting woes, that’s not too much of a concern. And it may provide the cash-flow relief the team needs to get the deal done.