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A synthetic protective put strategy for phased investment in projects without an outright deferral

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  • Sukanto Bhattacharya

Abstract

In this paper we propose and computationally demonstrate a synthetic protective put strategy for real options. Specifically, we deal with the problem of deferral option when an outright deferral is not permissible due to competitive pressures. We demonstrate that in such a situation an appropriate strategy would be to invest in the new project in phases rather than doing it all at once. By setting the owner’s equity in the project equal to the price of a call option on the value of the project, we set up the replicating portfolio for a protective put on the project. Our method is a logical extension of the financial protective put in the real options scenario and is rather simple and practicable for businesses to adopt and apply.

Suggested Citation

  • Sukanto Bhattacharya, 2005. "A synthetic protective put strategy for phased investment in projects without an outright deferral," Finance 0507005, EconWPA, revised 05 Jul 2005.
  • Handle: RePEc:wpa:wuwpfi:0507005
    Note: Type of Document - pdf; pages: 18
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    References listed on IDEAS

    as
    1. Pindyck, Robert S., 1993. "Investments of uncertain cost," Journal of Financial Economics, Elsevier, vol. 34(1), pages 53-76, August.
    2. Bhattacharya, Sudipto, 1978. "Project Valuation with Mean-Reverting Cash Flow Streams," Journal of Finance, American Finance Association, vol. 33(5), pages 1317-1331, December.
    3. Cox, John C. & Ross, Stephen A. & Rubinstein, Mark, 1979. "Option pricing: A simplified approach," Journal of Financial Economics, Elsevier, vol. 7(3), pages 229-263, September.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    synthetic protective put; replicating portfolio; deferral option;

    JEL classification:

    • G - Financial Economics

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