Types of real options- AFM BY TAHA POPATIA

There are many different classifications of real options. For the purposes of the AFM syllabus, we use
the following four generic headings:

Option to delay an investment until new

information is available. This happens when a
company has exclusive rights to a project or
product, it can delay taking this project or product
until a later date. It creates a call option. For
example, a company paid certain amount to
OPTION TO DELAY/DEFER acquire a license to produce a particular product
anytime over the period of coming 4 years.
Assume that the net present value today for
investment is negative. The company may decide
to invest further amount at any time over the
license period if the net present value will become
positive.
It exists when the company can use its productive
assets for activities other than the original one.
This may occur when the forecasts of the activity
OPTION TO SWITCH/REDEPLOY that was initially started may turn out to be wrong
and it could be beneficial to stop the project and
use resources somewhere else. It creates a put
option.
It exists when firms invest in projects which allow
them to make further investments in the future or
to enter new markets. The initial investment may
OPTION TO EXPAND/FOLLOW-ON be considered as a premium payment. Further
investment is undertaken only if the present value
from the expansion will be higher than the
additional investment. It creates a call option.
It is the option to abandon a project during its life.
This option might be used if the forecast initially
OPTIONS TO ABANDON prepared turn out to be incorrect or new
information changes the expected payback. It
creates a put option.

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