If an oil well allows the investor the option to drill later, what must happen for the option to be exercised?
A)Interest rates must increase.
B)The probability of oil prices increasing must be less than the probability of oil prices decreasing.
C)Oil prices must be high relative to possible future prices.
D)The present value of oil must be higher than the future value of oil.

Question

Quizplus · Accepted Answer

The option to drill later is a form of investment with a call option. The investor will exercise the option if the spot price of oil is high enough compared to the possible future spot price. Therefore, the answer is C, oil prices must be high relative to possible future prices. The other options are not relevant to the decision to exercise the option.

If an Oil Well Allows the Investor the Option to Drill