# FAQ Number 10

## Is the Options Decision Rule (Invest at or Above the
Threshold Curve) the Policy to Get the Maximum Option Value?

How Much Value I Lose If I Invest a Little Above or Little Below the
Optimum Threshold?

Answer: yes, **investing at the threshold line
you maximize the option value**.

But sometimes you don't lose much investing **near of the optimum**
(instead *at* the optimum).

Example: oilfield development as American call option. Suppose oil
prices follow a GBM. By running the simple real options model (using
"Timing", for example) you draw the
theoretical threshold curve.

For example, two **sub-optimal** option exercise policy are:

- to invest ~10% below the theoretical threshold line;
- to invest only when the underlying asset reaches a value ~10% above
the threshold line.

The picture below illustrates these sub-optimal thresholds lines.

The option value is calculated by running a Monte Carlo valuation of
these sub-optimal strategies, that is, by generating risk neutral sample
paths for the oil prices evolution and computing the option values
according that threshold line. The option is exercised if the path hit the
sub-optimal threshold (of course the option only can be exercised once for
each sample path).

The expected present value for each sub-optimal strategy is calculated and
compared with the theoretical real option value.

The chart below presents this analysis for sub-optimal strategies, not
only for +/- 10% but for several levels of sub-optimal thresholds (%
distance from the theoretical optimal threshold).

I find out here that the optimum is over a “plateau” (optima
region) not a “hill”.

So, investing ~ 10% above or below the theoretical optimum gets rough
the same value. But investing ~20% (or more) below the theoretical
threshold the losses are very important.

Now the relation optimum with option premium is clear (see the picture
below): near of the point A (theoretical threshold) the option premium can
be very small, so that investing **near** of A is sufficient
for practical maximization value purposes.

Go to the Next FAQ: 11) How real options sees
the choice of mutually exclusive alternatives to develop a project?

Back to the FAQ's List
Back to Contents