Real Option


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.


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.

  1. Derivative

    A security with a price that is dependent upon or derived from ...
  2. European Option

    An option that can only be exercised at the end of its life, ...
  3. Call

    1. The period of time between the opening and closing of some ...
  4. Strike Price

    The price at which a specific derivative contract can be exercised. ...
  5. Embedded Option

    A provision in a security that is an inseparable part of the ...
  6. American Option

    An option that can be exercised anytime during its life. American ...
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  1. How do hedge funds use equity options?

    With the growth in the size and number of hedge funds over the past decade, the interest in how these funds go about generating ... Read Full Answer >>
  2. Can mutual funds invest in options and futures?

    Mutual funds invest in not only stocks and fixed-income securities but also options and futures. There exists a separate ... Read Full Answer >>
  3. What is the utility function and how is it calculated?

    In economics, utility function is an important concept that measures preferences over a set of goods and services. Utility ... Read Full Answer >>
  4. How does a forward contract differ from a call option?

    Forward contracts and call options are different financial instruments that allow two parties to purchase or sell assets ... Read Full Answer >>
  5. How long does it take to execute an M&A deal?

    Even the simplest merger and acquisition (M&A) deals are challenging. It takes a lot for two previously independent enterprises ... Read Full Answer >>
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