What is an option contract?

"An options contract is an agreement between a Buyer and Seller that gives the purchaser of the option the right to buy or sell a particular asset at a later date at an agreed upon price. Options contracts are often used in securities and commodities industries"

As the definition states, and option contract is where one party holds an asset, in the aviation industry it would be the parts needed to repair or maintain the aircraft, and sells the option to buy the asset or aircraft part to the Buyer who only buys the asset or part when and if needed.

Buyers pay what is called a "premium" or contract cost to the Seller in order for the Seller to hold the inventory or assets instead of selling the inventory or assets to another party. The "premium" is a minimal percentage of the agreed value of the asset, which gives the Buyer full access (the option) to the part as and when needed, while not committing all the funds needed to buy the part outright. Should the Buyer not require the asset or aircraft part, they do not need to try and sell the part or continue holding the inventory, the only cost was the "premium" paid for the option contract, with the asset remaining the property of the seller of the option contract.

In the aviation industry, airlines and operators of aircraft have a constant need for parts in order to maintain and repair their fleet. Option contract's allow the airlines and operators a way to insure against the risk of not having inventory of a specific part at a specific location at the lowest cost.

Airline A purchases the option contract from MRO B for an engine. The contract states the location of the engine, the engine serial numbers, condition and the price that MRO B will sell the engine to Airline A at the time that Airline A chooses to purchase the engine. The option contract is for a fixed period (typically 3 months) and if the Airline does not choose to purchase the engine during the period of the contract, MRO B can then sell the engine or another option to Airline A or whoever they choose.

The option contract binds the Seller of the aircraft part and contract to hold the inventory for the Buyer of the contract, and to sell the part when the Buyer chooses to purchase under the contract. The option contract will remove costly inventory from the airlines and operators, allowing them to use their capital more effectively in flying their passengers or cargo, while allowing them to own under contract more inventory in more locations at lower costs than before.