Another type of option is the "American" option. This may be exercised at any point in time up to the maturity of the option. Remember that the "European" can only be exercised at the maturity of the option. An interesting property of the American Option is that it is never optimal to exercise the option prior to maturity except if the underlying is about to pay out a large dividend. This has an important consequence for "Real Options". It is never optimal to exercise an option early. In other words making decisions before you need to on a project destroys value for the project. Project Managers who make decisions to in order to show progress on a project are destroying value.
Consider the following scenario that we are all too familiar with in the IT Projects World. Company X needs a new system to manage Blueberrys. There are several vendors in the market. An initial survey of these solutions indicates that only five are serious contenders. On a traditional project, the project team would make a decision to select a single solution as soon as possible. They would then perform the due diligence on the single solution and specify the additional changes needed to the product. An alternative options based approach would be to perform the due diligence on all five solutions and then make the decision as late as possible. The additional cost of performing the due diligence on the other solutions should be considered as the option premium to cover the uncertainty in the requirements which will only be fully known at a later date.
Posted by chrismatts at May 8, 2004 6:46 PM