Demystifying Real Options A Comprehensi 2023 10 08

The idea that financial options are like corporate investments because they create future opportunities is appealing. It makes sense and is also becoming more accepted by people in general. Executives readily see why investing today in R&D, a new marketing program, or even certain capital expenditures (a phased plant expansion) can generate the possibility of new products or markets tomorrow. However, transitioning from understanding to acting, from the financial options of puts and calls to actual investment decisions, is complex and deeply frustrating for many non-finance managers.
Experts in option pricing have said that more traditional analyses like discounted cash flow (DCF) and net present value (NPV) must include the same things that option pricing does. In addition, simple option pricing for exchange-traded puts and calls is relatively easy to understand, and many puts and calls present the basics clearly and concisely. But at that point, most executives get stuck. As a result, corporate analyses that generate real numbers have been rare, expensive, and hard to understand.