# Real Options: Calculating the “option to switch use” using binomial lattices

I'm currently looking into calculating the "option to switch use" to determine the benefit of the ability to switch between two technologies at any point in time (american option). This is also called an "exchange option" for financial options.

Trigeorgis calculates the value of flexibility in his book (p173) as: $F(A \rightarrow B) = S_0(A \rightarrow B) + S_1(A \rightarrow B) + S_2(A \rightarrow B)$

where $S_t$ is the value of the option at each point in time when switching from technology A to technology B. The value of the option is therefore calculated as the sum(!) of the options values from each point in time backwards to $t=0$.

Unfortunately there is no explanation there why this is treated different than any other calculation of a binomial lattice I found. In any other case I found there is just one backwards pass calculated to find the value at the root node. This final value is then treated as the value of the option.

Edit: Question: Why is Trigeorgis calculating the option value differently than everyone else?

Any insights would be greatly appreciated!

regards, Bernhard

• Interesting. While I'm not exactly sure what you are asking, I'd be very curious to learn how you came up with spot price, correlation and volatility for 2 pieces of technology. – amdopt Apr 14 '17 at 18:27
• It is stated that the volatility needs to be correlated between both assets, in most documents you can find they are just assumed to be equal. The value of the underlying is the PV of the project and the parameters for the binomial lattice are determined by using monte carlo analysis – Bernie Apr 14 '17 at 18:39
• @amdopt you probably want to take a look at: "Mun - Real Options Analysis Tools & Techniques" – Bernie Apr 14 '17 at 18:42
• Thanks @Bernie. I have used exchange options in the past but never with anything outside the realm of financial products. – amdopt Apr 14 '17 at 18:44
• @amdopt I'm interested in everything related to that matter, do you know of any literature about valuation of exchange options by using binomial trees? – Bernie Apr 14 '17 at 18:46