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Real Option
What does it mean?
An alternative or choice that becomes available with a business investment opportunity.
In Other Words...
Note that this kind of option is not a derivative instrument, but an actual option (in the sense of "choice") that a business may gain by undertaking certain endeavors. For example, by investing in a particular project, a company may have the real option of expanding, downsizing, or abandoning other projects in the future. Other examples of real options may be opportunities for R&D, M&A, and licensing.
They are referred to as "real" because they usually pertain to tangible assets, such as capital equipment, rather than financial instruments. Taking into account real options can greatly effect the valuation of potential investments. Oftentimes, however, valuation methods, such as NPV, do not include the benefits that real options provide.
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Related Terms
American Option | Call | Derivative | Embedded Option | European Option | Intrinsic Value | Leverage | Options Contract | Strike Price | Writer
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