Definition of Real Option Valuation

Real option is an actual option (in the sense of “choice”) that a business may gain by undertaking certain endeavors. The real option captures the value of managerial flexibility to adapt decisions by expanding, downsizing, or abandoning investment projects in the future in response to unexpected market developments. In this context, real option valuation model applies basically the same theory and calculation formula as the financial option pricing models to quantify the value of management flexibility in a world of uncertainty.