Real options in leasing semi-submersible rigs in the North Sea

We consider the effect of idle time for pricing extension, termination and assignment options on short-term leases. The area of application covers capital intensive equipment performing specific functions and services. Examples include leases for semi-submersible drilling rigs, marine seismic services, corporate real estate leasing, retail space leasing and apartment leasing. The critical factor in pricing options on these services is the idle time between leases relative to the market state. The market state is determined by the level of equipment or service utilization and both the actual and expected future demand. We show that the inclusion of idle time can act as a positive or negative modifier on extension option prices and always as a positive modifier on termination and assignment options with a simple analytic model using realistic parameter values for semi-submersible drilling services in the North Sea. A positive modifier can lead to an increased option price and a negative modifier may be used to offer more competitive contracts. We also develop a discrete event simulation based framework suitable for more complex situations.