Real Options (Luehrman)

Knowledge Center

Summary, forum, best practices, expert tips and information sources.

35 items • 263.562 visits



What are Real Options? Description

Real Options capture the value of managerial flexibility to adapt strategic decisions in response to unexpected market developments. A company creates shareholder value by identifying Real Options, managing of Real Options, and exercising Real Options, associated with its investment portfolio. The Real Options method applies financial options theory to quantify the value of management flexibility, thus turning uncertainty to its advantage in a changing world.

The idea of treating strategic investments as financial options was conceived by Timothy A. Luehrman in two HBR articles: "Investment Opportunities as Real Options: Getting Started on the Numbers" (July-August 1998) and "Strategy as a Portfolio of Real Options" (September-October 1998). In the last article Luehrman says: "In financial terms, a business strategy is much more like a series of options than a series of static cash flows".

Use of Real Options. Benefits

As a result of the above, when valuations involve significant future flexibility or uncertainty and/or future cash-flows alone are close to break-even, flexibility is a major source of value, and option value must be taken into consideration. Note that the first mentioned circumstance is typical for strategic scenarios. And even for strategic decision-making in general.

Formula of Real Options. Calculation

Formula used is Black-Scholes or other similar. Generally, the following variables determine the value of having (an) option(s) - option value:

  • Time to expiration (duration).

  • Degree of uncertainty.

  • Cost of acquiring the option(s).

  • Potential cash flows lost, compared to full upfront commitment.

  • Risk-free interest rate.

  • Expected present value of future cash flows.

By introducing these factors into business decision-making, the Real Options method has enabled corporate decision-makers to use uncertainty for the advantage of the firm, and to create a limit to downside risk.

Special Interest Group

Real Options Special Interest Group.

Special Interest Group
Special Interest Group (121 members)


Forum discussions about Real Options. Below you can ask a question about this topic, share your experiences, report a new development, or explain something.

topic Applicability of Real Options in Oil and Gas Field Development
How to use the real option technique for the appraisal of oil & gas field development projects?...
Comments4 comments
🔥 Real Options: Measures to Cut Costs
The problem with strategic cost cutting is it is bounded from below by zero. A crisis to one is an opportunity to another if only one knows how to embrace risks....
topic Real Options Applied to Rapid Labour Mobilization
In some industries, the speed of mobilization of labour coupled with the ready availability of skilled labour is a determinant of success, e.g. Oil and gas drilling when prices rise. I would be intere...

Start a new topic

Start a new topic about Real Options

Best Practices

The best, top-rated topics about Real Options. Here you will find the most valuable ideas and practical suggestions.

Expert Tips

Advanced insights about Real Options. Here you will find professional advices by experts.


Key Behaviors of Innovative Organizations

Innovation Management, Culture Change, Organizational Change, Innovative Culture, Organizational Culture
Many large-scale attempts to make organizations more innovative are experiencing organizational inertia, barriers and/or...

How to Become a Self-tuning Enterprise: Advanced Experimenters

Organizational Agility, Strategic Agility, Real Options, Emergent Strategy
In an HBR article of June 2015, Reeves, Zeng and Venjara argue there's a new way to apply algorithmic principles that en...

How to Design Experiments to Support Decision-making on Strategic Innovations

Strategic Innovation, Strategic Decision-making, Strategic Experimenting, Experiments, Strategic Testing, Innovation Tes
The probability of success of a major innovation is difficult to assess. Statistics and other datasets only provide info...

How to Link Risk Management and Strategy?

Strategic Risk Management, Best Practices
Firms practicing strategic risk management: 1. Create value by embracing risks, shaping risks, and exploiting flexibili...

Align Strategy and Risk Management

Performance-Aligned Risk Management
In a recent white paper titled "Foundations of GRC: Enhancing Business Performance Through Risk Management", which was p...

Taking Risk Management from Control and Compliance into a Competitive Advantage

Strategic Risk Management
Since events tend to be repetitive over time, many management experts support the idea that an effective risk management...

Why Society is More Risky than Before

Understanding New Risk Categories, Risk Management
In his 1992 book "Risk Society: Towards a New Modernity”, Ulrich Beck describes new risk scenarios that companies have t...

Real Options and Brand Value

Exploiting Real Options
A brand can be considered as a feature that allows a firm to gain a unitary profit margin higher than those of products ...
Information Sources

Various sources of information regarding Real Options. Here you will find powerpoints, videos, news, etc. to use in your own lectures and workshops.


Scenario Planning and Risk Management in Uncertain Business Enviroment

Scenario Planning, Risk Management, Strategic Uncertainty
Extensive and detailed presentation. Topics: - Integrated Risk Management Framework - Strategic Management Framework ...

Important Issues Involving Real Options

Real Options, Capital Budgeting
This paper by Gordon Sick and Andrea Gamba provides an introduction to real options, as well as highlights some importan...

The Six Basic Questions of Risk Management: Introduction to Risk Management

Initial Understanding of Risk Management, Risk Management Introduction
Managing risk is essentially a process of asking and answering six relatively easy questions no matter what setting (per...

Financial Flexibility Option

Valuing financial flexibility
This model estimates the value of financial flexibility, i.e, the maintenance of excess debt capacity or back-up financi...

Delay Option

Valuing delay option
This model estimates the value of the option to dealy in an investment project. By Aswath Damodaran."...

Expand Option

Valuing expand option
This model estimates the value of the option to expand in an investment project. Modified, it can also be used to assess...

Rules of Thumb in Real Options Analysis

Real Options Analysis
In this normative paper, Giuseppe Alesii derives payback period (PBP) and internal rate of return (IRR) in the presence ...

Abandoning Option

Valuing abandoning option
This model estimates the value of the option to abandon a project or investment. By Aswath Damodaran....

Research Links

Jump to further research sources regarding Real Options.













Compare with: Scenario Planning  |  Credit Risk Management  |  Strategic Risk Management  |  PEST Analysis  |  Analogical Strategic Reasoning  |  Root Cause Analysis  |  CAPM  |  Dialectical Inquiry  |  Plausibility Theory  |  Theory of Constraints  |  Operations Research

Return to Management Hub: Change & Organization  |  Decision-making & Valuation  |  Finance & Investing  |  Knowledge & Intangibles  |  Strategy & Innovation

More Management Methods, Models and Theory

Special Interest Group

Special Interest Group

Do you know a lot about Real Options? Become our SIG Leader and gain worldwide recognition as an expert.

About 12manage | Advertising | Link to us / Cite us | Privacy | Suggestions | Terms of Service
© 2023 12manage - The Executive Fast Track. V16.3 - Last updated: 28-9-2023. All names ™ of their owners.

12manage is looking for BA/MBA students. More info.