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Real Options, the Living Dead, and how to play the possibility of failure in the financial markets

I’m a big fan of thinking of bets in highly uncertain environments in terms of options.  With growth options, I usually advise thinking of new opportunities as options – in which you place a small bet with a contained downside, that buys you the right, but not the obligation to make bigger bets later on.  Thus, you spread your risks, and if you win, you have the potential to win big.

A recent note in the Wall Street Journal speculated that investors are making exactly the opposite bets in the case of companies suffering in the current downturn.  The ‘cheap’ buy is actually the depressed stock of a company in trouble.  Although some are likely to go bust, the options bet is that a few will survive, draw the attention of other investors, and pay a nice return to those steadfast enough to purchase when things looked grim. 

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