Contenido

La flexibilidad de la que dispone la dirección de la empresa –es decir, las "opciones reales"– genéricamente, se relacionará con el tamaño del proyecto, el momento del proyecto y la marcha del proyecto una vez se haya iniciado.[19]​ En todos los casos, cualquier gasto inicial (no recuperable) relacionado con esta flexibilidad es la prima de la opción. Las opciones reales también se aplican comúnmente a la valoración de acciones bursátiles.

Options related to project size

When the scope of the project is uncertain, flexibility in the size of relevant facilities is valuable and an option.[20]​.

• - Expansion option: The project is built with a production capacity greater than expected demand so that it can produce at a higher rate if necessary. Company management then has the option to increase production if conditions prove favorable. A project with an expansion option will cost more than one without (the difference is the option premium) but it will also be worth more. The extension option is, therefore, equivalent to a purchase option (call).

• - Reduction option: The project is designed in such a way that production can be reduced in the future if conditions turn out to be unfavorable. Exercising the option consists of giving up these future expenses. This is the equivalent of a put option and, again, the initial excess expense is the option premium.

• - Option to expand or reduce: the project is designed in such a way that it can be started or stopped as appropriate. Management can close part—or all—of the trade when conditions are unfavorable (put option) and can restart trades when conditions improve (call option). A good example is the flexible manufacturing system (FMS). This option is also known as switching option.

Options related to the life of the project and its scheduling

Where there is uncertainty about when and how commercial or other conditions will materialise, schedule flexibility for relevant projects is valuable and an option. Growth options are perhaps the most generic in this category. They involve the option of pursuing only those projects that appear to be profitable at the time of initiation.

• - Start or Postponement Options: Here management has flexibility regarding when to start a project. For example, in the exploitation of natural resources, a company can delay the extraction of a deposit until market conditions are favorable. This constitutes an American-style purchase option.

• - Delay option with a product patent: A company with a patent right on a product has the right to develop and market the product exclusively until the expiration of the patent (typically about 20 years from when the patent is applied for). The company will market and develop the product only if the present value of the expected cash flows from sales of the product exceeds the development cost. If this does not occur, the company can file the patent and not incur additional costs.

• - Abandonment option: Management may have the option to stop a project during its life and possibly obtain its salvage value. Here, when the present value of the remaining cash flows falls below the liquidation value, the asset can be sold, and this involves exercising a put option. This abandonment option is also known as Termination option. The dropout options are American style.

• - Sequencing options: this option is related to the previous start option, although it implies flexibility regarding the schedules of interrelated projects. In this case, the analysis must elucidate whether it is better to carry out the projects sequentially (mathematical succession) (one after the other) or in parallel (at the same time). For example, a mining company is considering building a train line to a port and some silos there. If the sequential option is chosen, by observing the results related to the first project, the company can remove some of the uncertainty related to the initiative as a whole. Once cleared, management has the option of whether or not to continue with the development of the other projects. If, on the other hand, the parallel option is chosen, when the first project is finished, the others will be advanced and money will have been spent on them, so the opportunity cost of not undertaking them is lost. Likewise, execution time is reduced, so the resulting assets will begin to produce benefits sooner. Project sequencing is important in corporate strategy. The notion of intraproject (within the same project) and interproject (between several projects) options is related to sequencing.

• - Prototyping option: some systems are incremental innovations of existing systems (whose functioning is well known), while others are radical innovations (which cannot be predicted how they will work). The latter are risky investments. Prototyping can cover some of these risks, because it costs much less than a full-scale system, and yet allows reliable information to be obtained about how that system would work economically and technically. In economic terms, prototyping is a risk hedging option (like the famous hedge options). This option has a cost that must be properly evaluated.[21]​ For example, new energy generation and storage systems are continually being developed due to climate change, resource scarcity and environmental laws.

Options related to project operation

Management may have flexibility regarding the products produced or the processes used in manufacturing. As in the previous cases, this flexibility increases the value of the project, corresponding in turn to the "premium" paid for the real option.

• - Product mix options: The option to produce different products from the same facility is known as product mix option or product flexibility. These options are particularly valuable in industries where demand is volatile or where total quantities demanded for a particular good are typically low, and management would want to switch to a different product quickly if necessary. An example is the nougat industry, with demand concentrated at Christmas, which can adapt its machinery to produce ice cream in the low season.[22]​.

• - Input Mixing Options: Also called process flexibility**,** this option allows management to use different inputs to produce the same result, as appropriate. For example, a farmer will consider the option of switching between several feed sources (hay, feed) and will prefer to use the cheapest acceptable alternative. An electric company may have the option to choose between several forms of electricity generation (hydroelectric, thermal).

• - Operational scale options: Management may have the option to change the quantity of production per unit of time, or change the total duration of production run time, for example, in response to market conditions. These options are also known as intensity options. They are very common in the automobile industryː if there is a lot of demand, a third shift is set up.[23]​.

Teniendo en cuenta lo anterior, está claro que existe una analogía entre las opciones reales y las opciones financieras,[24]​ y, por lo tanto, cabría esperar que para las primeras se pudieran aplicar modelos y análisis que llevan tiempo utilizándose en las segundas. Sin embargo, es importante entender por qué algunas técnicas estándar de valoración de opciones financieras pueden no ser aplicables para la valoración de opciones reales (ROV por sus siglas en inglés).[2]​.

Applicability of standard techniques

ROV is often contrasted with more standard capital budgeting techniques, such as discounted funds flow (DCF) analysis or net present value (NPV).[2]​ Under this "standard" NPV approach, expected future cash flows are valued in the present based on the measure of empirical probability at a discount rate that reflects the risk implicit in the project (see Financial Asset Pricing Model, Arbitrage Theory, and Weighted Average Cost of Capital). Only expected cash flows are considered here, without taking into account the "flexibility" to change corporate strategy based on actual behavior (see below also Corporate finance § Assessing flexibility).

The NPV framework assumes (implicitly) that management is “passive” with respect to its capital investment once committed. Some analysts take account of this uncertainty (i) by adjusting the discount rate, for example by increasing the cost of capital, or (ii) by adjusting cash flows, for example by using certainty equivalents, or (iii) by applying (subjective) "trims" to the forecast numbers, or (iv) through probability weighting of these as in rVAN.[25][26] However, even when the latter methods are employed, they typically do not take into account. adequately address changes in risk over the project life cycle and therefore fail to appropriately adapt risk adjustment.[27]​[28]​.

Instead, ROV assumes that management is “active” and can respond “continuously” to market changes. Real options evaluation considers "all" scenarios (or "states") and indicates the best corporate action in each of them.[29]​ Because management adapts to each negative outcome by decreasing its exposure, while adapting to positive scenarios by increasing its scale, the company benefits from the uncertainty in the underlying market, achieving lower earnings variability than with NPV analysis.

The contingent nature of future earnings in real options models is captured using techniques developed for financial options in the contingent rights analysis literature. The approach here, known as risk-neutral valuation, is to adjust the probability distribution to account for risk, while discounting at the risk-free rate. This technique, also known as the "martingale" approach (in Spanish one of the meanings of this word is "deception",[30] but originally martingale is a French game of chance that uses probability in a certain way), uses a measure of risk neutrality. For technical considerations see below.

Given these different treatments, the value of a project estimated with real options analysis is usually greater than that estimated with NPV, and the difference will be more marked in projects with greater flexibility, contingency and volatility.[31]​ This is analogous to financial options where a greater volatility of the underlying "Volatility (finance)") leads to a greater value (precisely financial options are to protect against this volatility, so that, the greater the volatility, the more expensive they cost).

An application of real options valuation in the Philippine banking industry showed that higher levels of income volatility can negatively affect the values ​​of real options in the loan portfolio, when the presence of information asymmetry is considered. In this case, increased volatility can limit the value of a real option.[32]​.

Part of the criticism of real options pricing (and the subsequent slow adoption in practice and academia) comes from the generally higher values ​​it yields for business assets. However, studies have shown that these values ​​are reliable estimates, as long as the input data are appropriately identified.[33]​.

Options Based Valuation

Although there is much similarity between the modeling of real options and that of financial options,[24][34]​ ROV is distinguished from the latter in that it takes into account the uncertainty about the future evolution of the parameters that determine the value of the project, along with the capacity of management to respond to this evolution.[35][36]​.

It is the combined effect of this uncertainty and this capability that makes the ROV technically more complex than its alternatives. The full range of possible values ​​for the asset must first be estimated. This involves estimating what its value would be if it existed today (usually it is a project, so it does not exist yet) and forecasting the set of possible future values. These calculations provide numbers for all possible option values ​​at the different points where a decision is needed about whether to proceed with the project.

When valuing the real option, the analyst must therefore consider the factors (inputs) that affect the value of a real option, the valuation method used and whether technical limitations can be applied. Conceptually, the valuation of a real option analyzes the premium between what the company pays for a certain project and what that project yields (the money it gives). The factors that affect the value of a real option (time, interest rates, volatility, cash inflows and outflows) are affected by the business conditions and the environment in which the project operates. Business conditions (such as ownership information, data collection costs, or patents) depend on the political, environmental, sociocultural, technological, and legal situations affecting an industry.

Just as the environment affects business conditions, it also affects the volatility of returns, the interest rate and the projections of payments and returns of a project.[37]​.

Given the similarity in the valuation approach, the factors necessary to model the real option correspond to those necessary for the valuation of a financial option.[24]​[34]​[35]​ However, the specific application for real options is as follows:.

• - The underlying of the option is the project in question. It is modeled in terms of:

• Spot price: The initial or present value of the project is required: this is usually based on management's "best guess" as to the gross cash flow value of the project and the resulting net present value;

• Volatility "Volatility (finance)"): A measure of the uncertainty as to the change in value over time is required.

• Generally, the volatility in the value of the project is used, normally obtained through the Monte Carlo method.[35]​[38]​ Sometimes the volatility of the cash flows of the first period is preferred[36]​ (see below in Corporate Finance for an explanation related to the estimation of the NPV and the volatility of the project).

La relevancia de las opciones reales, incluso como marco mental, puede verse limitada debido a consideraciones de mercado, organizativas o técnicas.[48]​ Cuando se emplea el marco, por lo tanto, el analista debe considerar previamente lo siguiente para determinar si la ROV es relevante para el proyecto en cuestión.

Market characteristics

As already explained, the market and environment underlying the project must be those in which "change is most evident", and the "source, trends and evolution" in the supply and demand of the product create the "flexibility, contingency and volatility"[31]​ that result in optionality. In other cases it is better to use the VAN method.

Organizational considerations

Real options are "particularly important for companies with some key characteristics",[31]​ and may be less relevant in other cases.[36]​ In summary, it is important to consider the following in determining whether the ROV framework is applicable:.

1. • The corporate strategy has to adapt to contingent events. Some corporations face organizational rigidities and cannot react to market changes; In this case, the NPV approach is more appropriate.

2. • In practice, the company must be positioned in such a way that it has an adequate flow of information and opportunities to act. Often this will be a market leader or a company that enjoys economies of scale and scope.

3. • Management must understand options, be able to identify and create them, and exercise them appropriately.[16]​ This contrasts with business leaders focused on maintaining the status quo or short-term accounting profits.

4. • The financial position of the company must be such that it has the ability to finance the project when necessary (i.e., issue shares, take on more debt or use internally generated cash flow). Management must, therefore, have appropriate access to this capital.

5. • Management must be able to exercise real options. Some may be exercised by a single party, while others may require the agreement of several.

Technical considerations

Limitations in the use of these models arise due to the contrast between real options and financial options, for which these models were originally developed. The main difference is that the underlying is often not tradable on a stock market – for example, the owner of the factory cannot sell it easily and quickly, as he can with a stock. Furthermore, the real option itself may also not be (in this stock market sense) negotiable – for example, the factory owner cannot sell the right to expand his factory to another party; only he can make this decision. However, some real options can be sold. For example, ownership of vacant land is a real option to develop it in the future. Even where a market exists – for the underlying or for the option – in most cases market liquidity is limited (or non-existent). Finally, even if the company can actively adapt to market changes, the correct paradigm for discounting future claims remains to be determined.

The difficulties are then:

1. • As noted above, data issues arise regarding the estimation of key inputs to the model. In this case, since the value or price of the underlying cannot be observed (directly), there will always be uncertainty as to its value and volatility (in turn increased by uncertainty as to possible management actions in the future).

2. • It is often difficult to grasp the rules for the exercise of each of the real options and the consequent actions by management. Furthermore, a project may have a broad set of real options, some of which may be mutually exclusive.[16]​.

3. • Theoretical difficulties may also arise, which are more serious.

These problems are addressed through several interrelated assumptions:

1. • As explained above, data problems are usually addressed through a simulation of the project or a proxy listed on some stock exchange. Several new methods—such as those described above—also address these issues.

2. • Likewise, as noted above, specific exercise rules can often be accommodated by encoding them in a custom binomial tree.[49]​.

3. • Theoretical problems:

Although business managers have made capital investment decisions for centuries, the term "real option" is relatively new and was coined by Professor Stewart Myers of the MIT Sloan School of Management in 1977. In 1930, Irving Fisher wrote explicitly about the "options" available to the owner of a business (The Theory of Interest, II. viii). However, the description of such opportunities as "real options" followed the development of analytical techniques (such as the Black-Scholes Model in 1973) for financial options. For this reason the term "real option" is closely linked to these techniques.

Real options are today an active field of academic research. Professor Lenos Trigeorgis has been a prominent name for many years and has published several influential academic books and articles. Other pioneering scholars in the field include Professors Michael Brennan, Eduardo Schwartz, Graham Davis, Gonzalo Cortazar, Han Smit, Avinash Dixit, and Robert Pindyck (the latter two authors of the pioneering text in the discipline). An academic conference on real options is organized annually (Annual International Conference on Real Options).

Among others, the concept was popularized by Michael J. Mauboussin, then chief US investment strategist for Credit Suisse First Boston.[31] He uses real options to explain the gap between how the stock market values ​​some companies and the "intrinsic value (finance)" of those companies. Trigeorgis has also disseminated real options through articles (for laymen) in publications such as The Wall Street Journal.[29] This popularization is such that ROV is now a standard offering in graduate finance degrees and often even in MBA curricula at many business schools.

Recently, real options have been used in business strategy, both for valuation purposes and as a conceptual framework.[13]​[14]​ The idea of ​​treating strategic investments as options was popularized by Timothy Luehrman[50]​ in two HBR articles:[24]​ "In financial terms, a business strategy is much more like a series of options than a series of static cash flows." Investment opportunities are plotted in an “option space” with dimensions of “volatility” and value-to-cost ratio (“NPVc”).

Luehrman also co-authored with William Teichner a Harvard Business School case study, Arundel Partners: The Sequel Project, in 1992, which may have been the first business school case study to teach ROV. Reflecting the "integration" of ROV, Professor Robert C. Merton discussed Arundel's essential points in the lecture he gave upon receiving the Nobel Prize in 1997.[52] Arundel involves a group of investors considering acquiring the rights to sequels to a portfolio of yet-to-be-released feature films. In particular, investors must determine the value of the rights to these sequels before any of the first films are produced. Here, investors are faced with 2 main options: they can produce an original film and a sequel at the same time or they can wait to decide on a sequel after the original film is released. The second approach, Merton says, provides the option of not shooting the sequel in the event that the initial film is not successful. This real option has economic value and can be valued monetarily using an option pricing model.

• - Cost-benefit analysis.

• - Cost-effectiveness analysis.

• - Opportunity cost.

• - Purchase option (Right) "Purchase option (Right)").

Standard texts:.

• - Kodukula, P., & Papudesu, C. (2006). Project valuation using real options: a practitioner's guide. J. Ross Publishing. ISBN 978-1932159431.

Applications:.

• - Grenadier, Steven R. & Weiss, Allen M., 1997. "Investment in technological innovations: An option pricing approach," Journal of Financial Economics, Elsevier, vol. 44(3), pages 397–416, June.

• - The Impact of Real Options in Agency Problems G. Siller-Pagaza, G. Otalora, E. Cobas-Flores (2006).

Theory

• - Introduction to real options valuation as a modeling problem Archived November 15, 2012 at the Wayback Machine., Mikael Collan.

• - The promise and peril of real options, Prof. Aswath Damodaran, Stern School of Business.

• - Real Options Tutorial, Prof. Marco Dias, PUC-Rio.

• - Valuation of real options: frequent errors, Prof. Pablo Fernández, IESE Business School, University of Navarra.

• - Identifying real options, Prof. Campbell R. Harvey. Duke University, Fuqua School of Business.

• - An introduction to real options Archived May 25, 2012 at the Wayback Machine. (Southern African Society of Investment Analysts), Prof. E. Gilbert, University of Cape Town.

• - Decision making under uncertainty: real options to the rescue?, Prof. Lucas Miller and Chan Park, Auburn University.

• - Real Options White Papers and Case Studies Archived February 8, 2012 at the Wayback Machine., Dr. Jonathan Mun.

• - Real options – Introduction, Portfolio Group.

• - How do you evaluate the value of a company's "real options"? Archived October 20, 2019 at the Wayback Machine., Prof. Alfred Rappaport Columbia University and Michael Mauboussin.

• - Some important issues involving real options: an overview, Gordon Sick and Andrea Gamba (2005).

• - Real Power of Real Options, Leslie and Michaels (1997), Keith Leslie and Max Michaels McKinsey Quarterly, 1997 (3) pages 4–22. Quoted by Robert Merton in his Nobel Prize acceptance speech in 1997. McKinsey Classic - Reprinted in McKinsey Anthology 2000 - On Strategy. Quoted in McKinsey Anthology 2011 - Have you tested your strategy lately?

Magazines

• - Real Options Magazine.

• - Magazine of Real Options and Strategy.

Calculation resources

• - ROV Spreadsheet Models, Prof. Aswath Damodaran, Stern School of Business.

• - Real Options Calculator, Prof. Steven T. Hackman, Georgia Institute of Technology.

Contenido

La flexibilidad de la que dispone la dirección de la empresa –es decir, las "opciones reales"– genéricamente, se relacionará con el tamaño del proyecto, el momento del proyecto y la marcha del proyecto una vez se haya iniciado.[19]​ En todos los casos, cualquier gasto inicial (no recuperable) relacionado con esta flexibilidad es la prima de la opción. Las opciones reales también se aplican comúnmente a la valoración de acciones bursátiles.

Options related to project size

When the scope of the project is uncertain, flexibility in the size of relevant facilities is valuable and an option.[20]​.

• - Expansion option: The project is built with a production capacity greater than expected demand so that it can produce at a higher rate if necessary. Company management then has the option to increase production if conditions prove favorable. A project with an expansion option will cost more than one without (the difference is the option premium) but it will also be worth more. The extension option is, therefore, equivalent to a purchase option (call).

• - Reduction option: The project is designed in such a way that production can be reduced in the future if conditions turn out to be unfavorable. Exercising the option consists of giving up these future expenses. This is the equivalent of a put option and, again, the initial excess expense is the option premium.

• - Option to expand or reduce: the project is designed in such a way that it can be started or stopped as appropriate. Management can close part—or all—of the trade when conditions are unfavorable (put option) and can restart trades when conditions improve (call option). A good example is the flexible manufacturing system (FMS). This option is also known as switching option.

Options related to the life of the project and its scheduling

Where there is uncertainty about when and how commercial or other conditions will materialise, schedule flexibility for relevant projects is valuable and an option. Growth options are perhaps the most generic in this category. They involve the option of pursuing only those projects that appear to be profitable at the time of initiation.

• - Start or Postponement Options: Here management has flexibility regarding when to start a project. For example, in the exploitation of natural resources, a company can delay the extraction of a deposit until market conditions are favorable. This constitutes an American-style purchase option.

• - Delay option with a product patent: A company with a patent right on a product has the right to develop and market the product exclusively until the expiration of the patent (typically about 20 years from when the patent is applied for). The company will market and develop the product only if the present value of the expected cash flows from sales of the product exceeds the development cost. If this does not occur, the company can file the patent and not incur additional costs.

• - Abandonment option: Management may have the option to stop a project during its life and possibly obtain its salvage value. Here, when the present value of the remaining cash flows falls below the liquidation value, the asset can be sold, and this involves exercising a put option. This abandonment option is also known as Termination option. The dropout options are American style.

• - Sequencing options: this option is related to the previous start option, although it implies flexibility regarding the schedules of interrelated projects. In this case, the analysis must elucidate whether it is better to carry out the projects sequentially (mathematical succession) (one after the other) or in parallel (at the same time). For example, a mining company is considering building a train line to a port and some silos there. If the sequential option is chosen, by observing the results related to the first project, the company can remove some of the uncertainty related to the initiative as a whole. Once cleared, management has the option of whether or not to continue with the development of the other projects. If, on the other hand, the parallel option is chosen, when the first project is finished, the others will be advanced and money will have been spent on them, so the opportunity cost of not undertaking them is lost. Likewise, execution time is reduced, so the resulting assets will begin to produce benefits sooner. Project sequencing is important in corporate strategy. The notion of intraproject (within the same project) and interproject (between several projects) options is related to sequencing.

• - Prototyping option: some systems are incremental innovations of existing systems (whose functioning is well known), while others are radical innovations (which cannot be predicted how they will work). The latter are risky investments. Prototyping can cover some of these risks, because it costs much less than a full-scale system, and yet allows reliable information to be obtained about how that system would work economically and technically. In economic terms, prototyping is a risk hedging option (like the famous hedge options). This option has a cost that must be properly evaluated.[21]​ For example, new energy generation and storage systems are continually being developed due to climate change, resource scarcity and environmental laws.

Options related to project operation

Management may have flexibility regarding the products produced or the processes used in manufacturing. As in the previous cases, this flexibility increases the value of the project, corresponding in turn to the "premium" paid for the real option.

• - Product mix options: The option to produce different products from the same facility is known as product mix option or product flexibility. These options are particularly valuable in industries where demand is volatile or where total quantities demanded for a particular good are typically low, and management would want to switch to a different product quickly if necessary. An example is the nougat industry, with demand concentrated at Christmas, which can adapt its machinery to produce ice cream in the low season.[22]​.

• - Input Mixing Options: Also called process flexibility**,** this option allows management to use different inputs to produce the same result, as appropriate. For example, a farmer will consider the option of switching between several feed sources (hay, feed) and will prefer to use the cheapest acceptable alternative. An electric company may have the option to choose between several forms of electricity generation (hydroelectric, thermal).

• - Operational scale options: Management may have the option to change the quantity of production per unit of time, or change the total duration of production run time, for example, in response to market conditions. These options are also known as intensity options. They are very common in the automobile industryː if there is a lot of demand, a third shift is set up.[23]​.

Teniendo en cuenta lo anterior, está claro que existe una analogía entre las opciones reales y las opciones financieras,[24]​ y, por lo tanto, cabría esperar que para las primeras se pudieran aplicar modelos y análisis que llevan tiempo utilizándose en las segundas. Sin embargo, es importante entender por qué algunas técnicas estándar de valoración de opciones financieras pueden no ser aplicables para la valoración de opciones reales (ROV por sus siglas en inglés).[2]​.

Applicability of standard techniques

ROV is often contrasted with more standard capital budgeting techniques, such as discounted funds flow (DCF) analysis or net present value (NPV).[2]​ Under this "standard" NPV approach, expected future cash flows are valued in the present based on the measure of empirical probability at a discount rate that reflects the risk implicit in the project (see Financial Asset Pricing Model, Arbitrage Theory, and Weighted Average Cost of Capital). Only expected cash flows are considered here, without taking into account the "flexibility" to change corporate strategy based on actual behavior (see below also Corporate finance § Assessing flexibility).

The NPV framework assumes (implicitly) that management is “passive” with respect to its capital investment once committed. Some analysts take account of this uncertainty (i) by adjusting the discount rate, for example by increasing the cost of capital, or (ii) by adjusting cash flows, for example by using certainty equivalents, or (iii) by applying (subjective) "trims" to the forecast numbers, or (iv) through probability weighting of these as in rVAN.[25][26] However, even when the latter methods are employed, they typically do not take into account. adequately address changes in risk over the project life cycle and therefore fail to appropriately adapt risk adjustment.[27]​[28]​.

Instead, ROV assumes that management is “active” and can respond “continuously” to market changes. Real options evaluation considers "all" scenarios (or "states") and indicates the best corporate action in each of them.[29]​ Because management adapts to each negative outcome by decreasing its exposure, while adapting to positive scenarios by increasing its scale, the company benefits from the uncertainty in the underlying market, achieving lower earnings variability than with NPV analysis.

The contingent nature of future earnings in real options models is captured using techniques developed for financial options in the contingent rights analysis literature. The approach here, known as risk-neutral valuation, is to adjust the probability distribution to account for risk, while discounting at the risk-free rate. This technique, also known as the "martingale" approach (in Spanish one of the meanings of this word is "deception",[30] but originally martingale is a French game of chance that uses probability in a certain way), uses a measure of risk neutrality. For technical considerations see below.

Given these different treatments, the value of a project estimated with real options analysis is usually greater than that estimated with NPV, and the difference will be more marked in projects with greater flexibility, contingency and volatility.[31]​ This is analogous to financial options where a greater volatility of the underlying "Volatility (finance)") leads to a greater value (precisely financial options are to protect against this volatility, so that, the greater the volatility, the more expensive they cost).

An application of real options valuation in the Philippine banking industry showed that higher levels of income volatility can negatively affect the values ​​of real options in the loan portfolio, when the presence of information asymmetry is considered. In this case, increased volatility can limit the value of a real option.[32]​.

Part of the criticism of real options pricing (and the subsequent slow adoption in practice and academia) comes from the generally higher values ​​it yields for business assets. However, studies have shown that these values ​​are reliable estimates, as long as the input data are appropriately identified.[33]​.

Options Based Valuation

Although there is much similarity between the modeling of real options and that of financial options,[24][34]​ ROV is distinguished from the latter in that it takes into account the uncertainty about the future evolution of the parameters that determine the value of the project, along with the capacity of management to respond to this evolution.[35][36]​.

It is the combined effect of this uncertainty and this capability that makes the ROV technically more complex than its alternatives. The full range of possible values ​​for the asset must first be estimated. This involves estimating what its value would be if it existed today (usually it is a project, so it does not exist yet) and forecasting the set of possible future values. These calculations provide numbers for all possible option values ​​at the different points where a decision is needed about whether to proceed with the project.

When valuing the real option, the analyst must therefore consider the factors (inputs) that affect the value of a real option, the valuation method used and whether technical limitations can be applied. Conceptually, the valuation of a real option analyzes the premium between what the company pays for a certain project and what that project yields (the money it gives). The factors that affect the value of a real option (time, interest rates, volatility, cash inflows and outflows) are affected by the business conditions and the environment in which the project operates. Business conditions (such as ownership information, data collection costs, or patents) depend on the political, environmental, sociocultural, technological, and legal situations affecting an industry.

Just as the environment affects business conditions, it also affects the volatility of returns, the interest rate and the projections of payments and returns of a project.[37]​.

Given the similarity in the valuation approach, the factors necessary to model the real option correspond to those necessary for the valuation of a financial option.[24]​[34]​[35]​ However, the specific application for real options is as follows:.

• - The underlying of the option is the project in question. It is modeled in terms of:

• Spot price: The initial or present value of the project is required: this is usually based on management's "best guess" as to the gross cash flow value of the project and the resulting net present value;

• Volatility "Volatility (finance)"): A measure of the uncertainty as to the change in value over time is required.

• Generally, the volatility in the value of the project is used, normally obtained through the Monte Carlo method.[35]​[38]​ Sometimes the volatility of the cash flows of the first period is preferred[36]​ (see below in Corporate Finance for an explanation related to the estimation of the NPV and the volatility of the project).

La relevancia de las opciones reales, incluso como marco mental, puede verse limitada debido a consideraciones de mercado, organizativas o técnicas.[48]​ Cuando se emplea el marco, por lo tanto, el analista debe considerar previamente lo siguiente para determinar si la ROV es relevante para el proyecto en cuestión.

Market characteristics

As already explained, the market and environment underlying the project must be those in which "change is most evident", and the "source, trends and evolution" in the supply and demand of the product create the "flexibility, contingency and volatility"[31]​ that result in optionality. In other cases it is better to use the VAN method.

Organizational considerations

Real options are "particularly important for companies with some key characteristics",[31]​ and may be less relevant in other cases.[36]​ In summary, it is important to consider the following in determining whether the ROV framework is applicable:.

1. • The corporate strategy has to adapt to contingent events. Some corporations face organizational rigidities and cannot react to market changes; In this case, the NPV approach is more appropriate.

2. • In practice, the company must be positioned in such a way that it has an adequate flow of information and opportunities to act. Often this will be a market leader or a company that enjoys economies of scale and scope.

3. • Management must understand options, be able to identify and create them, and exercise them appropriately.[16]​ This contrasts with business leaders focused on maintaining the status quo or short-term accounting profits.

4. • The financial position of the company must be such that it has the ability to finance the project when necessary (i.e., issue shares, take on more debt or use internally generated cash flow). Management must, therefore, have appropriate access to this capital.

5. • Management must be able to exercise real options. Some may be exercised by a single party, while others may require the agreement of several.

Technical considerations

Limitations in the use of these models arise due to the contrast between real options and financial options, for which these models were originally developed. The main difference is that the underlying is often not tradable on a stock market – for example, the owner of the factory cannot sell it easily and quickly, as he can with a stock. Furthermore, the real option itself may also not be (in this stock market sense) negotiable – for example, the factory owner cannot sell the right to expand his factory to another party; only he can make this decision. However, some real options can be sold. For example, ownership of vacant land is a real option to develop it in the future. Even where a market exists – for the underlying or for the option – in most cases market liquidity is limited (or non-existent). Finally, even if the company can actively adapt to market changes, the correct paradigm for discounting future claims remains to be determined.

The difficulties are then:

1. • As noted above, data issues arise regarding the estimation of key inputs to the model. In this case, since the value or price of the underlying cannot be observed (directly), there will always be uncertainty as to its value and volatility (in turn increased by uncertainty as to possible management actions in the future).

2. • It is often difficult to grasp the rules for the exercise of each of the real options and the consequent actions by management. Furthermore, a project may have a broad set of real options, some of which may be mutually exclusive.[16]​.

3. • Theoretical difficulties may also arise, which are more serious.

These problems are addressed through several interrelated assumptions:

1. • As explained above, data problems are usually addressed through a simulation of the project or a proxy listed on some stock exchange. Several new methods—such as those described above—also address these issues.

2. • Likewise, as noted above, specific exercise rules can often be accommodated by encoding them in a custom binomial tree.[49]​.

3. • Theoretical problems:

Although business managers have made capital investment decisions for centuries, the term "real option" is relatively new and was coined by Professor Stewart Myers of the MIT Sloan School of Management in 1977. In 1930, Irving Fisher wrote explicitly about the "options" available to the owner of a business (The Theory of Interest, II. viii). However, the description of such opportunities as "real options" followed the development of analytical techniques (such as the Black-Scholes Model in 1973) for financial options. For this reason the term "real option" is closely linked to these techniques.

Real options are today an active field of academic research. Professor Lenos Trigeorgis has been a prominent name for many years and has published several influential academic books and articles. Other pioneering scholars in the field include Professors Michael Brennan, Eduardo Schwartz, Graham Davis, Gonzalo Cortazar, Han Smit, Avinash Dixit, and Robert Pindyck (the latter two authors of the pioneering text in the discipline). An academic conference on real options is organized annually (Annual International Conference on Real Options).

Among others, the concept was popularized by Michael J. Mauboussin, then chief US investment strategist for Credit Suisse First Boston.[31] He uses real options to explain the gap between how the stock market values ​​some companies and the "intrinsic value (finance)" of those companies. Trigeorgis has also disseminated real options through articles (for laymen) in publications such as The Wall Street Journal.[29] This popularization is such that ROV is now a standard offering in graduate finance degrees and often even in MBA curricula at many business schools.

Recently, real options have been used in business strategy, both for valuation purposes and as a conceptual framework.[13]​[14]​ The idea of ​​treating strategic investments as options was popularized by Timothy Luehrman[50]​ in two HBR articles:[24]​ "In financial terms, a business strategy is much more like a series of options than a series of static cash flows." Investment opportunities are plotted in an “option space” with dimensions of “volatility” and value-to-cost ratio (“NPVc”).

Luehrman also co-authored with William Teichner a Harvard Business School case study, Arundel Partners: The Sequel Project, in 1992, which may have been the first business school case study to teach ROV. Reflecting the "integration" of ROV, Professor Robert C. Merton discussed Arundel's essential points in the lecture he gave upon receiving the Nobel Prize in 1997.[52] Arundel involves a group of investors considering acquiring the rights to sequels to a portfolio of yet-to-be-released feature films. In particular, investors must determine the value of the rights to these sequels before any of the first films are produced. Here, investors are faced with 2 main options: they can produce an original film and a sequel at the same time or they can wait to decide on a sequel after the original film is released. The second approach, Merton says, provides the option of not shooting the sequel in the event that the initial film is not successful. This real option has economic value and can be valued monetarily using an option pricing model.

• - Cost-benefit analysis.

• - Cost-effectiveness analysis.

• - Opportunity cost.

• - Purchase option (Right) "Purchase option (Right)").

Standard texts:.

• - Kodukula, P., & Papudesu, C. (2006). Project valuation using real options: a practitioner's guide. J. Ross Publishing. ISBN 978-1932159431.

Applications:.

• - Grenadier, Steven R. & Weiss, Allen M., 1997. "Investment in technological innovations: An option pricing approach," Journal of Financial Economics, Elsevier, vol. 44(3), pages 397–416, June.

• - The Impact of Real Options in Agency Problems G. Siller-Pagaza, G. Otalora, E. Cobas-Flores (2006).

Theory

• - Introduction to real options valuation as a modeling problem Archived November 15, 2012 at the Wayback Machine., Mikael Collan.

• - The promise and peril of real options, Prof. Aswath Damodaran, Stern School of Business.

• - Real Options Tutorial, Prof. Marco Dias, PUC-Rio.

• - Valuation of real options: frequent errors, Prof. Pablo Fernández, IESE Business School, University of Navarra.

• - Identifying real options, Prof. Campbell R. Harvey. Duke University, Fuqua School of Business.

• - An introduction to real options Archived May 25, 2012 at the Wayback Machine. (Southern African Society of Investment Analysts), Prof. E. Gilbert, University of Cape Town.

• - Decision making under uncertainty: real options to the rescue?, Prof. Lucas Miller and Chan Park, Auburn University.

• - Real Options White Papers and Case Studies Archived February 8, 2012 at the Wayback Machine., Dr. Jonathan Mun.

• - Real options – Introduction, Portfolio Group.

• - How do you evaluate the value of a company's "real options"? Archived October 20, 2019 at the Wayback Machine., Prof. Alfred Rappaport Columbia University and Michael Mauboussin.

• - Some important issues involving real options: an overview, Gordon Sick and Andrea Gamba (2005).

• - Real Power of Real Options, Leslie and Michaels (1997), Keith Leslie and Max Michaels McKinsey Quarterly, 1997 (3) pages 4–22. Quoted by Robert Merton in his Nobel Prize acceptance speech in 1997. McKinsey Classic - Reprinted in McKinsey Anthology 2000 - On Strategy. Quoted in McKinsey Anthology 2011 - Have you tested your strategy lately?

Magazines

• - Real Options Magazine.

• - Magazine of Real Options and Strategy.

Calculation resources

• - ROV Spreadsheet Models, Prof. Aswath Damodaran, Stern School of Business.

• - Real Options Calculator, Prof. Steven T. Hackman, Georgia Institute of Technology.