| Option
time value illustrates the risk/reward
trade-off |
A prospective client
with stock options tells you they are waiting for the
stock price to hit a certain target before they will
consider diversifying. Sound familiar? This is a tough
situation because the prospect who uses stock price as
their sole indicator for taking action doesn't generally
need the assistance of a financial advisor.
Stock price drives the in-the-money value of an
option, but stock price by itself is not necessarily a
good indicator of when to take action. There are
countless numbers of employees that road the dot com
boom up and back down to where it began because they set
an arbitrary price target that was never
achieved.
This time around option holders are
more likely to seek professional advice on how to
determine when to diversify their options.
However, the key to assisting these clients going
forward is being able to illustrate the risk/reward
trade-off in their option portfolios at any given
time.
The best metric for doing this is by
calculating the Time Value of an option using the
Black-Scholes formula. Time value is a function of the
time to expiration, the in-the-money value and the
volatility of the stock. The chart below shows the time
values and Black-Scholes values for six grants with
various expiration dates and strike prices.
The Black-Scholes Value (BSV)
is the time value plus the in-the-money value. The
highlighted grant (ISO1) is one year from expiration and
significantly in the money so the time value is very
small compared to the total BSV. This means that at the
present time this option has a relatively small amount
of upside potential ($5,729) and a large amount of
downside risk ($592,829). Explained this way, an option
holder may be more inclined to diversify now instead of
waiting until expiration. For more information on
Black-Scholes see the Technical
White Papers on our website.
There are a
number of unforeseeable events such as termination or
change of company ownership that require constant
vigilance of the risk/reward trade-off. For an excellent
perspective on how to avoid the most common stock option
mistakes see Beth Walker's article on myStockOptions.com.
Other
news from NWSI
- Our corporate education and planning program,
formerly know as "Corporate Optionee Services", has
been renamed StockOpter® Corporate Services.
This program markets and delivers equity compensation
education and planning services to companies who want
to ensure that their key employees understand and are
motivated by the wealth building potential of their
stock options and restricted grants.
- StockOpter© Corporate Services are now
marketed and delivered by 10 select advisory firms
from across the country who recently attended our
initial Boot Camp training program. We plan on
conducting a second Boot Camp in early June and
space is limited so email Bill Dillhoefer at mailto:%20bdillhoefer@networthstrategies.com
or call him at 877-728-5964 for information on how to
apply.
- Whether you're currently a StockOpter® user
or not, we can cost effectively help you prepare and
deliver stock option plans for your clients. Just give
us the grant data and a few assumptions and we will
create a Personal Option Profile© and review it with you for $195.
For more information on this analysis as well as more
complex tax planning visit the back
office services section on our website.
- The 2004 update for StockOpter® Pro will be
available shortly and all licensed users will be
notified via email on how to download and install it.
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