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Risk illustration of Employee Stock Options
 

Risk illustration of Employee Stock Options

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Proves that there is greater risk in employee stock options where the stock is moderately above the exercise price than deep in-the-money. ...

Proves that there is greater risk in employee stock options where the stock is moderately above the exercise price than deep in-the-money.

http://www.wiley.com/WileyCDA/WileyTitle/productCd-0470471921.html

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    Risk illustration of Employee Stock Options Risk illustration of Employee Stock Options Presentation Transcript

    • .Where is the Highest Risk when holding Employee Stock Options?The Matrix below shows the “fair value” of employee stock options at various stock prices at different times to expiration.Thisallows an examination of the changes in the ESOs value over times and the risks of holding the ESOs under different conditions.Exer. Pr..Stock Pr...Volatility...Days to Ex..Theo Val…...Time Val.50………50.00............35...........1400.........14.01...............14.01 …..The color equations below show50………56.25............35...........1400.........18.38...............12.13…....25% drops in the stocks causing50………75.00............35...........1400.........33.07 ………....8.07….…larger % drops in the ESOs with50………93.75 ..........35............1400..........49.48................5.75…....lower “intrinsic values” after 90050……..100.00...........35............1400.........55.21.................5.20…. ..days leaving 500 days to expiration50……. 125.00...........35............1400.........78.73............... 3.7350……..50.00............35............1000.........11.76..............11.76………33.07 to 12.35 = 20.72 = 63% drop50……..56.25............35............1000.........15.92................9.67……….55.21 to 27.42 = 27.79 = 50% drop50……..75.00............35............1000.........30.58................5.58 ………78.73 to 44.83 = 33.90 = 43% drop50……..93.75............35............1000.........47.22................3.4750……100.00............35............1000.........53.03................3.03………This is proof that when the stock50……125.00............35............1000.........76.93................1.93………is trading at $100 with an exercise price of $50, the risk is less than50……..50.00.............35............500............8.31................8.31………when the stock was trading at $75.50……..56.25.............35............500..........12.35................6.11………The higher risk is from the higher50……..75.00.............35............500..........27.42............... 2.47 ………volatility of the options values50……..93.75.............35............500..........44.83................1.18……….and the much larger erosion of50…….100.00............35............500..........50.97................0.97……….higher “time values” when the50…….125.00............35............500..........75.61................0.61……….stock is trading at lower prices.
    • .Exer. Pr....Stock Pr...Volatility...Days to Ex...Theo Val…...Time Val.50……....50.00.............35............500...........8.31................8.31………50……....56.25.............35............500......... 12.35...............6.11………50……....75.00.............35............500.........27.42............... 2.47 ………50……....93.75.............35............500.........44.83................1.18……….50……...100.00............35............500.........50.97................0.97………50…..….125.00............35............500.........75.61................0.61……….50…..… ..50.00.............35............100........3.68.................3.68........25 % stock drops over 400 days show greater percentage50…….. ..56.25.............35............100........7.82.................1.57........losses for the ESOs with lower "intrinsic values"50…….. ..75.00.............35............100.......25.12................0.12 ........27.42 to 7.82 = 71.5% drop50…….. ..93.75.............35............100.......43.83................0.08.........50.97 to 25.12 = 50.7% drop50……. .100.00............35.......... ..100........50.07................0.07........75.61 to 43.83 = 42.0% drop50……...125.00............35......... ...100........75.05................0.05If different % drops of the stock were examined, (for example 30 35, or 40% drops), the results of the % drops of theoptions would show greater % drops. If the drops occurred over longer periods, the % drops in the options would be greaterbecause of the erosion of the "time value".This means that if fiduciaries are concerned with risk reduction, they are required to reduce risk when the ESOs are mostrisky. And that occurs when the ESOs are moderately in-the-money. The strategy of early exercise, sell and diversify ishighly inappropriate when the ESOs are moderately in-the- money and is inappropriate except in rare situations. Theinappropriateness results from the required forfeiture of "time value" and the payment of an early tax and the questionablebenefits of "diversifying". That leaves only one choice to efficiently manage ESOs that are significant parts of theemployees assets. That is to sell calls or do other efficient risk reduction trades in the exchange traded markets
    • . http://www.amazon.com/John-Olagues/e/B00314DLEY