Real Options and Optionalities in Shipping

Abstract

In Chapters 7 and 8, we discussed options on shipping freight rates, hedging with freight options, as well as their pricing and trading strategies. In this chapter we explore the natural extension of these instruments for valuing flexibility and optionality in investment and operational projects using ‘real option analysis’ (ROA). Since there are a number of strategic and managerial flexibilities embedded in shipping investment and operations projects, we focus on the use of real option analysis in evaluating such optionalities in shipping. We also discuss several of the options that are embedded in shipping contracts such as the option to extend a time-charter contract, the option to place a newbuilding order, or a purchase option on a time-charter contract. These options and optionalities are used extensively in the shipping industry; however, in many cases they are granted for free or for a nominal fee without being properly valued. The issue of identifying and then pricing these options is the topic of this chapter.