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User Guide Navigation: Business Spreadsheets User Guides: Project Planning and Management Multiple Regression Analysis and Forecasting Investment and Business Valuation Real Options Valuation Portfolio Optimization Portfolio Performance Tracking Customer Invoicing Real Options Valuation Help Topics: Option Pricing Fundamentals The Option to Delay a Project The Option to Expand a Project The Option to Abandon a Project Binomial Option Pricing Game Theory Analysis 
An option represents the right to buy (call) or sell (put) a specific quantity of an asset at a fixed price (exercise price) at or before a specified date in the future. This right is not an obligation, therefore the holder can choose not to exercise the purchase or sale and allow the option to expire.
A Call Option gives the holder the right to buy an asset at a specified exercise price at any time before the specified expiry date, for which the holder pays a price for. At the expiry date, if the asset value is less than the exercise price, the asset is not purchased and the option expires worthless. Conversely, if the asset value exceeds the exercise price, the asset is purchased at the exercise price and difference represents the gross profit on the investment. The net profit is the difference between the gross profit and the price paid for the call. The options to Delay or Expand a business case or project are both variations of call options.
A Put Option gives the holder the right to sell an asset at a specified exercise price at any time before the specified expiry date, for which the holder pays a price for. At the expiry date, if the asset value is greater than the exercise price, the asset is not sold and the option expires worthless. Conversely, if the asset value is less than the exercise price, the asset is sold at the exercise price and difference represents the gross profit on the option. The net profit is the difference between the gross profit and the price paid for the put. The option to Abandon a business case or project is a variation of a put option.
The calculation of option value (call or put price) is accomplished in the model by employing modified versions of the BlackScholes model. It is not the purpose of this paper to detail the mathematical derivation of this calculation; however in broad terms the model employs the use of a 'replicating' portfolio consisting of the underlying asset and riskfree rate to determine the options value. Modifications are made to the model in order to account for:
Determinants of Option Value are essentially the inputs required for such a model. The following table summarizes the key inputs required for the modified BlackScholes models and their effect on the option values.
Input 
Effect of Increase in Input on values for: 

Call (Delay, Expand) 
Put (Abandon) 

Current value of underlying asset 
UP 
DOWN 
Variance in value of the underlying asset 
UP 
UP 
Dividends or cash flows from the asset 
DOWN 
UP 
Exercise Price of the option 
DOWN 
UP 
Time to expiration of the option 
UP 
UP 
Risk free interest rate for life of the option 
UP 
DOWN 
It should be noted that this model is essentially designed to value options on financially traded assets where inputs are readily available from market data sources. When applying such models to 'real' options, some alternative Adjustments and Assumptions can be made in order to assist application. The following underlying assumptions of the BlackScholes model illustrate this.
While making such adjustments to the inputs may seem to weaken the valuation process, it is the understanding of limitations and sensitivity to changes in these inputs that highlights the existence and value of strategic options apparent.
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