Your question is certainly multi-pronged.
Your first question addresses the typical issue of when a writer should accept a no- to low-money option payment For the purposes of this discussion, I will make the assumption that the producer is not a Writers Guild of America (WGA) signatory and you are not a WGA member or a what the WGA would deem a "professional writer" (i.e., you have written a screenplay or play that has been produced or a novel which has been published) since the WGA rules address several parts of your question. Typically a writer should receive some nominal option payment to show that the producer has some proverbial "skin in the game;" however, if a producer is independent and does not have a development fund from a studio or other company (and those arrangements have become increasingly fewer these days) and the producer has some sort of track record or contacts as well as a sincere "passion" for the screenplay, perhaps you could make the initial term nine months instead of a year or if the producer wishes to renew the option, then the producer would pay an option payment for the option extension. Or you could enter into a shopping agreement which has a shorter term. (Please read my article on "shopping agreements" for a discussion concerning them which can be found on this website.)
Concerning a free rewrite, there is a balance which must be achieved between a writer rendering a free rewrite and a polish or further writing services and not being compensated for numerous rewrites and polishes. That balance should be addressed in your agreement with a producer. For example, a writer will provide one rewrite and a polish but any additional writing services by the writer will be negotiated in good faith by the parties. A writer should bear in mind that once a writer begins to request compensation or additional compensation for writing services, the producer may decide to engage another writer (who will work no or less money or has a track record to justify the producer paying more money for the writing services) especially if the agreement between the parties permits or does not prohibit the producer from doing so. It is a dilemma which many writers have to face.
If the project proceeds to production, you would be paid the purchase price for the rights to your screenplay (which would be a fixed figure or a percentage of the project’s budget). In addition, there may be a bonus which you could receive for your writing services if the project goes to production, especially if it is produced by a studio, network or so-called "mini-major."
A writer also can receive a profit participation anywhere from two to five percent of the producer’s share of the net profits. Sometimes the profit participation is called "net proceeds," "adjusted gross proceeds," or "modified gross proceeds." The label of the profit participation is not as important as how such profit participation is defined, calculated and paid to a writer as a profit participant. The best that most profit participants such as writers can achieve is to tie how the writer’s profit participation is defined, calculated and paid to that of any other person’s or entity’s profit participant’s definition and manner of payment including that of the producer. This provision helps to keep the playing field level concerning profit participation.
A writer’s agreement should state that there shall be accounting statements which shall be received by the writer which are issued on the same basis as any other profit participant in terms of form and frequency (e.g., quarterly for the first two years after the initial commercial exploitation of the film, twice a year for another two years and annually thereafter). A writer’s agreement should include a right to examine or formally audit the producer’s books, records and other documents pertaining to how a motion picture feature’s revenues are calculated and received by a producer. This examination or audit right is usually exercisable by a potential profit participant once per year. In some cases, if the right is not exercised within a certain period of time (usually twenty four months or more from when the potential profit participant receives a statement), the potential profit participant is barred from examining the producer’s books and records pertaining to that statement. Please bear in mind that such examinations and audits can cost from five thousand to ten thousand to more. The potential profit participant has to assume the cost of the examination or audit; however, a provision could be included in an agreement which states that if one is underpaid by a certain percentage (e.g., 5%-10%), then the producer is required to pay the underpayment immediately and to assume the cost of the examination or inspection.
Finally, many distributors and producers do not need to falsify or "cook" the books since the profit definitions are so inclusive that every expense (including interest) is taken before there would be any profits. In addition, there are certain parties such as "star" directors, producers and performers who may receive their contingent compensation earlier in the economic "food chain" than the net profit participants, thereby eliminating or lessening the possibility of net profit participants receiving any monies. That is why such films as "Fatal Attraction" and "Coming To America" can generate large revenues but minimal to no profits and even losses.