![]() ![]() Let’s take a quick look at a simplified, practical example.Īssume I own a power plant that can be stopped and started periodically. Using financial options pricing theory you can evaluate the value of your real optionality and manage your assets’ options accordingly. Some types of real options are to make an investment or undertake a new project, to defer a decision until a later point or to shut down a project due to unfavorable conditions and then resume those operations when conditions become favorable again. What those options are will vary depending on what the asset may be. Shifting the premise from financial assets to real assets, the owner of a tangible asset has the right, but not the obligation, to make decisions (i.e., exercise options) pertaining to the management and operation of the owned asset. In short, the owner has the right, but not the obligation, to buy (call option) or sell (put option) the asset at the strike price on or before the expiration date. ![]() The theory of real options is rooted in the mathematics of financial options, in which the owner of an option may buy or sell an underlying asset at a preestablished price within a given time frame. ![]() Real options theory applies a decision-making process to support the exercise of these options. How you exercise these options can have material impact on the value of your assets and the profitability of your business. In business, just as in real life, many options present themselves. Or maybe you accept, starting a butterfly effect of further optionality: buying a house, having kids, saving for college or taking family vacations. Maybe you turned down the proposal thinking someone better will come along. Or if you resisted the initial temptation, maybe the ice cream in your freezer presents a more compelling argument later that night. If you eat the donut, maybe you decide to go to the gym after work and burn it off. Often the exercise of one option can lead to further optionality. Or maybe you are in a relationship, and your partner proposes: Do you take the option to marry, or do you keep your options open and stay single? You have the option of treating yourself with a donut or staying on track with your weight loss goals. You’re on a diet and you’re counting calories. In life, everyone confronts innumerable options on a daily basis. ![]()
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