Real Option

AAA

DEFINITION of 'Real Option'

An alternative or choice that becomes available with a business investment opportunity. Real options can include opportunities to expand and cease projects if certain conditions arise, amongst other options. 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 affect the valuation of potential investments. Oftentimes, however, valuation methods, such as NPV, do not include the benefits that real options provide.

INVESTOPEDIA EXPLAINS 'Real Option'

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.

RELATED TERMS
  1. European Option

    An option that can only be exercised at the end of its life, ...
  2. Options Contract

    A contract that allows the holder to buy or sell an underlying ...
  3. American Option

    An option that can be exercised anytime during its life. American ...
  4. Leverage

    1. The use of various financial instruments or borrowed capital, ...
  5. Writer

    The seller of an option who collects the premium payment from ...
  6. Intrinsic Value

    1. The actual value of a company or an asset based on an underlying ...
RELATED FAQS
  1. What risks should I consider taking a short put position?

    The risks to consider before taking a short put position are the odds of sustained weakness in the asset price and a spike ... Read Full Answer >>
  2. What happens if a software glitch fails to execute the strike price I set?

    If you've ever suffered the frustrating experience of having an order not filled or had a strike price fail to execute because ... Read Full Answer >>
  3. How is a tender offer used by an individual, group or company seeking to purchase ...

    A tender offer is made directly to shareholders in a publicly traded company to gain enough shares to force a sale of the ... Read Full Answer >>
  4. In what market situations might a short put be a profitable trade?

    Short puts would be a profitable trade in low-volatility bull markets or range-bound markets. Selling puts is a strategy ... Read Full Answer >>
  5. How does a company record profits using the equity method?

    A company that invests in another company and has majority control of it would record profits using the equity method. This ... Read Full Answer >>
  6. What is the relationship between implied volatility and the volatility skew?

    The volatility skew refers to the shape of implied volatilities for options graphed across the range of strike prices for ... Read Full Answer >>
Related Articles
  1. Investing Basics

    Pin Down Stock Price With Real Options

    How can you assign a value to what a company may do with its business in the future? We explain how it works.
  2. Options & Futures

    Using Decision Trees In Finance

    These decision-making tools play an integral role in corporate finance and economic forecasting.
  3. Fundamental Analysis

    Taking Stock Of Discounted Cash Flow

    Learn how and why investors are using cash flow-based analysis to make judgments about company performance.
  4. Professionals

    Top 10 Ways To Avoid Burnout In Corporate Finance

    Burnout rates in the corporate finance field are extremely high. Find out some of the most common causes, and how to prevent them.
  5. Economics

    Understanding Limited Liability

    Limited liability is a legal concept that protects equity owners from personal losses due to their ownership interest in the company.
  6. Investing Basics

    What is a Greenshoe Option?

    A greenshoe option is a provision in an underwriting agreement that allows the underwriter to buy up to 15% of the shares in an IPO at the offer price.
  7. Fundamental Analysis

    Explaining the Empirical Rule

    The empirical rule provides a quick estimate of the spread of data in a normal statistical distribution.
  8. Economics

    Explaining Demographics

    Demographics is the study and categorization of people based on factors such as income level, education, gender, race, age, and employment.
  9. Fundamental Analysis

    Calculating Degree of Financial Leverage

    Degree of financial leverage (DFL) is a metric that measures the sensitivity of a company’s operating income due to changes in its capital structure.
  10. Investing Basics

    What Does a Clearing House Do?

    A clearing house is a third-party agency or separate entity that acts as a go-between for buyers and sellers in financial markets.

You May Also Like

Hot Definitions
  1. Bund

    A bond issued by Germany's federal government, or the German word for "bond." Bunds are the German equivalent of U.S. Treasury ...
  2. European Central Bank - ECB

    The central bank responsible for the monetary system of the European Union (EU) and the euro currency. The bank was formed ...
  3. Quantitative Easing

    An unconventional monetary policy in which a central bank purchases private sector financial assets in order to lower interest ...
  4. Current Account Deficit

    A measurement of a country’s trade in which the value of goods and services it imports exceeds the value of goods and services ...
  5. International Monetary Fund - IMF

    An international organization created for the purpose of: 1. Promoting global monetary and exchange stability. 2. Facilitating ...
  6. Risk-Return Tradeoff

    The principle that potential return rises with an increase in risk. Low levels of uncertainty (low-risk) are associated with ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!