An Application of Financial Mathematics, Using Real Option Analysis, on Coal Production and Logistics

We present an application of Financial Mathematics (using Real Option Analysis) to value the inherent optionality a coal producer has when mining and processing thermal coal. The pay-off of the physical option can be modelled as a spread option, whereby both the underlyings, and more unusually, the strike all follow stochastic processes. The volatilities for each are modelled to be stochastic. We derive a lower bound approximation to value the inherent optionality and compare this to Monte Carlo simulation