Excel Models
Value of Option
Financial options are equivalent to “the right to choose,” and they have their specific, calculable value…
Besides financial options, there are real options, whose identification, creation, and utilization are a priority task in strategic management…
Additionally, it is important to understand that the existence of options “in the future” affects strategic decisions “today”…
The diagram below shows a simple example of a real option and how the fact that you will have the ability to choose in the future change’s decisions in the present.
In the first case, to get from point “A” to point “B,” it is better to use the secondary road because there is a 40% probability of a traffic jam on the highway. The average expected time is 21 minutes, while the secondary road guarantees 20 minutes.
In the second case, the driver realizes that it is possible to change the decision. That is, they make a decision knowing that they can change it in the future. It is precisely this option that gives them the basis to change the decision… This future option reduces the average expected time from 21 minutes to 19 minutes if using the highway… So, the value of this choice option is 2 minutes…
P.S.
However, on the other hand, according to game theory, there are cases where the ability to choose creates problems… Competitors reach “Nash equilibrium” because of this problem, but that is a completely different topic of discussion…
Source of insight:
*Venture Capital & the Finance of Innovation – by A. Metrick & A. Yasuda