So far in this chapter, we have discussed several advanced options, including compound and rainbow options. Other more advanced options are discussed below, but they are not presented in any detail because they are beyond the scope of this book.

Switching options A switching option refers to the flexibility in a project to switch from one mode of operation to another. For example, a dual-fuel heater offers the option of switching from oil to natural gas and vice versa, depending on the relative market costs of these fuels. This flexibility has value and accounts for the price premium for dual-fuel heaters compared to single-fuel heaters.

Exit options As stated in Chapter 7, abandonment options are difficult to exercise due to political and psychological reasons. Abandonment option calls for abandonment of the project when the asset value goes below the strike price, but this reduction in asset value may be temporary and the asset value could bounce back above the strike price immediately thereafter. To avoid abandoning a project in such a situation, management may decide on a critical asset value that is smaller than the strike price before which the abandonment or exit option can be exercised. This critical value acts as a barrier below which the exit option will be exercised. Sometimes such an option is also referred to as a barrier option.

Complex compound options Earlier in this chapter, we discussed the sequential compound option, which...