I make a number of references to options throughout my Blog but what are they. My background is in financial seervices and financial options are a huge business. An option is "The Right but not the Obligation to buy or sell an asset at a predetermined price".
There are four classifications of options:
1. Exchange traded options
2. Over the Counter (OTC) options
3. Embedded Options
4. Real Options.
I will explain what each of them are and then move on to the use of real options in project management.
Exchange traded options are the most widely known. These are options traded on The Chicago Board of trade (CBOT), NYMEX, LIFFE and other financial markets. These options are normally based on equitues (stocks), interest rates and commodities. Two parties anonamously enter into an option ( a buyer and a seller ) via the exchange. The seller of the option charges the buyer a premium for the option. The standard options are European Puts and Calls. ''European" means that the option can only be exercised on the final date. A "Call" grants the option buyer the right to buy the underlying at a fixed price and a "Put" grants the option buyer the right to sell the underlying at a fixed price. These are normally valued using the Black Scholes equation.
Over the Counter or OTC Options are entered into directly by two parties, the buyer and the seller. These options are similarly based on equities, interest rates and commodities as well as exchange rates. Once again the buyer is charged a premium by the seller.
Embedded options are those that occur "naturally" within trading agreements between two parties. For example, where the buyer of bespoke software has the right to buy additional functionality at a fixed price. Normally the seller of the software and hence the option does not charge for the option.
Real Options are used as management decision tools. They are used to value decisions. Once again the Black Scholes equation is used although the Harvard Business Review recently contained an article on using the Cox Ross Rubinstein model as well.
Posted by chrismatts at May 8, 2004 6:31 PM