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Option Terminology and an Introduction to Binomial Trees

In: A Pragmatic Guide to Real Options

Author

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  • Tom Arnold

Abstract

In the first two chapters it was pointed out how limiting net present value (NPV) analysis can be and how making project decisions sequentially allows for better decision-making even though the risk of the project does not change. Each one of these decisions made through the lifetime of a project is a “real option” or simply an “option.” In this chapter, option terminology is introduced based on traded financial options. Understanding option terminology will help with reading the academic literature on real options. However, trying to describe a decision point as a specific type of option is really not necessary. Understanding when there is a crucial decision point and what factors should be considered in making the decision is more important than labeling the decision as this “type” of option. Consequently, as option terminology is being introduced, it will be put in the context of a traded financial option and within the context of a real option.

Suggested Citation

  • Tom Arnold, 2014. "Option Terminology and an Introduction to Binomial Trees," Palgrave Macmillan Books, in: A Pragmatic Guide to Real Options, chapter 0, pages 33-52, Palgrave Macmillan.
    • Handle: RePEc:pal:palchp:978-1-137-39116-2_3
    DOI: 10.1057/9781137391162_3
    as

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