In what way is the development of Antamina mine a real option? Compare it to a financial option. The Antamina mine case can be modeled as a real option. An option in financial terms is the right to buy/sell something, it is not mandatory to buy/sell, is a choice that the owner can do. If you can earn with the exercise of the option, you use your right, but if it is not the case you simply do not utilize it. In this way the return derived from an option is asymmetric.
In real term an option is defined as the flexibility a manager has to take decisions. For example if he can choose if take the decision to invest or not in a project, if develop or not a product, if expand or not the variety of services offered. They are “real” because concern the project and are in project in the sense that design the element of the system, but the characteristics of asymmetric returns, choice of use and sunk costs are the same of financial option.
The Net Present Value analysis not considers these options and believes that it is not possible to take decisions but they are predetermined. Instead the Real Options analysis takes in account of these flexibilities and evaluate their effect on the value of the project. The characteristics of a real option are mainly three: Timing Uncertainty Irreversibility In the Antamina case the characteristic of timing is two years, in fact is not necessary to take decision to develop or not the mine immediately.
The uncertainty concerns the value of the mine, the costs of the opening and the price of the metal that will extract. The irreversibility is about the option premium that is a cost not recoverable, if it is exercised or not the option you have to pay it. The option used is a call-like option (right to buy something to a predetermined price), so it is possible compare a common financial call option with the Antamina real one.
In a typical financial option the underlying asset is a stock, instead in the Antamina case it is the value of the mine, the value of the reserves of metal contained in it. The exercise price of a financial option is the strike price, the price at which you can buy/sell the option, instead in the case analyzed is the development cost of the mine. Comparing the maturities in the financial case is the time of the option, the time at which the option can be exercised, and in the real case is two years from now.
The volatility concern the stock price in financial option, in Antamina mine is the volatility of metal price and the volatility of reserve value. The main differences between a financial option and the real option in general are: the period (years) that is much longer than a financial option (three-six months), and the difficulty to model the future value of the asset that cannot be forecasted basing on the past observations. It is very important to take in account these considerations in the valuation of a project.