# Real Option

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## Definition of 'Real Option'

A real option is a financial instrument that gives the holder the right, but not the obligation, to buy or sell an underlying asset at a specified price on or before a specified date. Real options are often used to manage risk in businesses, and can be used to hedge against adverse events or to take advantage of opportunities.

There are two main types of real options: call options and put options. A call option gives the holder the right to buy the underlying asset at a specified price, while a put option gives the holder the right to sell the underlying asset at a specified price.

The value of a real option depends on the volatility of the underlying asset, the time to expiration, and the strike price. The volatility of the underlying asset is a measure of how much its price is likely to change over time. The time to expiration is the length of time until the option can be exercised. The strike price is the price at which the underlying asset can be bought or sold.

Real options can be used to manage risk in a number of ways. For example, a company can use a call option to hedge against the risk of rising prices for an input material. The company can buy a call option on the input material, which gives it the right to buy the material at a specified price. If the price of the input material rises, the company can exercise the option and buy the material at the lower strike price. This will protect the company from the higher cost of the input material.

Real options can also be used to take advantage of opportunities. For example, a company can use a put option to sell a product at a specified price. The company can sell a put option on its product, which gives someone else the right to sell the product to the company at a specified price. If the price of the product falls, the company can exercise the option and sell the product at the higher strike price. This will allow the company to lock in a profit on the product, even if the price falls.

Real options are a powerful tool for managing risk and taking advantage of opportunities. However, they can also be complex and risky. It is important to understand the risks involved before using real options.

There are two main types of real options: call options and put options. A call option gives the holder the right to buy the underlying asset at a specified price, while a put option gives the holder the right to sell the underlying asset at a specified price.

The value of a real option depends on the volatility of the underlying asset, the time to expiration, and the strike price. The volatility of the underlying asset is a measure of how much its price is likely to change over time. The time to expiration is the length of time until the option can be exercised. The strike price is the price at which the underlying asset can be bought or sold.

Real options can be used to manage risk in a number of ways. For example, a company can use a call option to hedge against the risk of rising prices for an input material. The company can buy a call option on the input material, which gives it the right to buy the material at a specified price. If the price of the input material rises, the company can exercise the option and buy the material at the lower strike price. This will protect the company from the higher cost of the input material.

Real options can also be used to take advantage of opportunities. For example, a company can use a put option to sell a product at a specified price. The company can sell a put option on its product, which gives someone else the right to sell the product to the company at a specified price. If the price of the product falls, the company can exercise the option and sell the product at the higher strike price. This will allow the company to lock in a profit on the product, even if the price falls.

Real options are a powerful tool for managing risk and taking advantage of opportunities. However, they can also be complex and risky. It is important to understand the risks involved before using real options.

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Copyright © 2004-2023, MyPivots. All rights reserved.