Aswath Damodaran: Real Options IntroductionVW Staff
In today’s class, I did a quick introduction to real options, setting up the intuitive rationale for real options. We covered the basics of options, starting with why real options are so attractive to analysts and investors: they allow you to add a premium to your DCF value. The two building blocks for real option value are learning (from what is going on around you or ongoing events) and adapting your behavior. There are three questions that underlie the use of real options. The first is recognizing when you are dealing with an option, with a payoff diagram being the give away. The second is looking for exclusivity which is what gives options value. The third is using an option pricing model, which is built on replication and arbitrage. We then turned our attention to the option to delay, an option that can make the rights to bad project/technology valuable. We used it as a lever to talk about valuing patents and natural resource reserves as options, with significant caveats on both.