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Daily Startup: Airfare Options Market

Updated: Jul 21, 2019

Hedge against volatility in future airfare pricing.

Airfare has gotten out of control, especially here in the states. It is an incredibly punitive market for the average consumer - poor protection accompanied with big price tags.

But what if that wasn't the case?

If you are ever looking to book airfare for a big trip, one of the hardest things to gauge is when to purchase tickets. Will the price go up? Go down? Kayak has a nifty little tool to give you some probability of price movement, but it's not terribly helpful. Orbitz has price match guarantee if there is a sudden drop within 24 hours of booking your trip....I can't imagine either of these are incredibly useful, especially when your trip is several months out.

So...

Why not create an options style market, similar to what is done for stocks? For those not well-versed in options trading, let's work through an example. These numbers are all made up to just illustrate the idea, so don't hold me to any of it!



1. Let's say, today's price for a round trip ticket from Chicago to Istanbul is $1500 for the dates of 02 SEP 19 - 16 SEP 19, roughly 8 weeks out.

2. As a consumer, I don't know if this will go up or down, and it's a large sum to commit to right now. So, I purchase an option for $20 which gives me the right to purchase the ticket for $1500 up until 30 JUL 19. If I wanted, I could spend $40 to purchase an option that would allow me to get the tickets for $1500 up until 15 AUG 19.

3. If the airfare price goes down by more than $20, my option is worthless, but I can then purchase the airfare for a lower price. Inversely, if the airfare goes up over the next few weeks, I can exercise my option and still get the $1500 price.

4. Adding to the complexity, let's say I purchased the option but now I don't want to go on the trip. No problem! If the airfare went up, my option is now worth something and I can potentially sell it off to someone else who wants the $1500 price. If the price is below $1500 when the option expires, then it would be worthless.


For businesses this could be a great way to lock-in and hedge travel expenses between common destinations, especially for companies with several office locations. The airlines, however, would need some incentive to let this happen as it would challenge their current pricing models. Perhaps they would get a royalty off of each options exchange, which could ultimately help subsidize airfare across the board. I have no idea.


Now this would open up a very strange derivatives market for airfare which wouldn't have the same liquidity as options written for stocks and bonds, but they would still be tied to a tangible asset - a seat. So, it should still be able to work. Given the time centricity of travel, it does lend itself to an options style contract or coupon.


Cheers


#dailystartup, #innovation, #travel


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