Alt Inv---Real option under uncertainity

CFA Level III
#1

what does this mean…

Oil futures market are often backwardated ie in these markets spot price are above the futures price.this may be caused by the existence of real options under uncertainity.

In other words,Producers are holding real options—options to …prpduce or not to produceand will not excercise them unless the spot price start to climb up…

Can u elaborate on real options…

#2

Real options were covered in Level II Corporate Finance. (You remember Level II, yes?)

There are a variety of real options:

  • Timing: investing now, or investing later.

  • Sizing: has two sub-types:

    • Abandonment: stop the project at some point.
    • Growth: expand the project at some point.

  • Flexibility: has two sub-types:

    • Price-setting: benefitting from excess demand when production cannot increase.
    • Production-flexibility: increasing or decreasing production as market prices change. This is the one they’re discussing in oil production.

  • Fundamental: investing or not investing.

#3

Thanks S2000!!!

i will have to revisit L2 real options and commodities…and come back again with the questions

#4

You’re quite welcome.

We’re always here when you have questions.

#5

Could someone please explain the answer to the question above i babish language. I dont have time to go to L2.