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Strategies & Market Trends : John Pitera's Market Laboratory -- Ignore unavailable to you. Want to Upgrade?

To: John Pitera who wrote (3946)	5/31/2001 12:17:51 AM
From: tyc:>	Respond to of 33421

>>what are the circumstances that have you posing this question? There is a concept in the mining industry described as "the option value of a mine". I have been pondering how such a valuation might be determined. I hang my hat on the principle that future free cash flow is the criterion of value. But the future free cash flow in mining varies with metal prices and metal prices are volatile. How then can conventional evaluation system produce a reasonable evaluation ? But option evaluation uses volatility. Perhaps the option value of a mine is the sum of calculated option premiums. I likened the cost of production to the strike price of an option. I don't think it is stretching too far to say that if the mine cannot meet its cash costs of production it will shut down. That seems comparable to an option holder saying he will not exercise if the strike price is higher that the price of the stock. I notice that there are such things as long term options on gold production. Kinross has sold options at a strike price of $340 for a term as long as four years, and ABX buys O/M calls to try to maintain volatility values . Would the option pricing models of these options be relevant to my purpose ? I cannot see why not. What I am really trying to determine is whether an interest rate factor should be reckoned into the option value of a mine. Or should we just figure in the price volatility of the commodity ? Hence my interest in the arbitrage involved. I sent my enquiry to heinz as well and in the ensuing PM correspondence he gave me a very satisfying answer. However I sure would be interested in your views too.

To: John Pitera who wrote (3946)	6/2/2001 8:09:45 AM
From: tyc:>	Read Replies (2) \| Respond to of 33421

one bit of advice: If someone is trying to sell you a Goose that is supposed to start laying 1 oz golden eggs in 4 years... I'd look askance at that investment opportunity Now that's funny! I should have replied in all seriousness; -No! What he wants to do is sell me an option to buy for $220 the egg that the goose will lay four years from now. ($220 is the amount it costs him to keep the goose for a year). The goose does exist now and is laying one egg each year. The current market price of an egg is $265. What is a fair price to pay today for that option ? Factors; 1. Todays price of gold 2. the volatility of the price of gold, (which affects directly the volatility of the value of the egg (FCF)) 3. the "probability weighting" that each future price point commands. (Black scholes says probabilities shd be acc. to a lognormal distribution curve) 4 What else ? Should we take into account the size of the goose's ovaries ? If we can figure out how much we should pay today for an option on each of the eggs the goose will lay in the future (Future FCF), haven't we figured out the present fair value of all future egg production ? Isn't that what the goose is worth ? The "Option value of Mines" is not MY idea. Simply trying to understand what it means.