Options on shipbuilding contracts

Abstract

Analysis of investment projects and strategic decisions using option theory has gained wide acceptance among corporate finance scholars and professionals. In the shipping and shipbuilding industries, option analysis is still in its infancy, and few professionals are familiar with option valuation tools. At the same time, practically all shipbuilding contracts contain option elements, the value of which most industry players do not know how to calculate. Newbuilding options give shipowners closing newbuilding contracts a right, but not an obligation, to enter into additional newbuilding contracts, with predetermined terms, at a later date. This thesis presents a general introduction to option theory as it applies to traded financial securities. This framework is extended to newbuilding options. Characteristics of the newbuilding markets are given, and fundamental stochastic processes that can describe newbuilding prices are introduced. Based on these stochastic processes, closed-form formulas for calculating the value of newbuilding options are presented. Actual observations of shipbuilding prices are analyzed in the context of the stochastic models. The results of this analysis are discussed as they apply to the option formulas and to the practical aspects of the newbuilding option framework. Recommendations are given on how to analyze real cases in which newbuilding options appear.