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Real Options

The concept of Real Options refers to making decisions in a way that preserves flexibility and optionality for the future. Borrowed from financial markets (where an "option" gives you the right but not the obligation to perform an action in the future), real options apply this thinking to real-life decisions—allowing you to adapt and respond effectively as new information arises.

Why Use Real Options?​

Real options add value by embedding flexibility into decisions, just as financial options add value by providing the right, but not the obligation, to take specific actions. This optionality often makes the real option more valuable than an otherwise identical alternative that lacks flexibility.

  • Preserves flexibility: Delays committing to irreversible decisions until you have sufficient information.
  • Manages uncertainty: Helps navigate uncertain environments by maintaining alternatives.
  • Improves strategic decision-making: Encourages evaluation of decisions based on potential future value, not just immediate outcomes.

Types of Real Options​

  • Option to Expand: Investing in a small-scale initial project with the possibility of scaling up if it proves successful.
  • Option to Cancel or Abandon: Retaining the flexibility to exit or stop a project if circumstances or outcomes are unfavorable.
  • Option to Delay: Postponing a decision or investment to wait for better information or more favourable conditions.
  • Option to Contract: Maintaining the ability to scale down or reduce the scope of operations or investments in response to changing conditions.
  • Option to Switch: Preserving the option to shift strategies, resources, or technologies if more attractive opportunities emerge.
  • Option to Stage: Implementing projects in phases or increments, allowing decisions to be adjusted or refined between stages.

Examples of Real Options​

Product Development​

Rather than investing heavily in one major product launch, companies might initially launch a minimum viable product (MVP). This provides the option to expand, pivot, or abandon based on customer feedback.

Career Decisions​

Choosing a job or skill development that opens multiple career paths represents an option to switch or expand into different industries or roles based on evolving preferences or market demand.

Real Estate Investment​

Purchasing land offers the option to delay development until market conditions become favourable, or to switch between different types of projects.

tip

Because optionality is valuable, it's usually helpful to ask the question "How can I structure this decision to maintain flexibility or create additional options?"