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Strategies & Market Trends : Employee Stock Options - NQSOs & ISOs -- Ignore unavailable to you. Want to Upgrade?

To: Stock Farmer who wrote (75)	6/18/2002 8:54:42 PM
From: rkral	Read Replies (1) \| Respond to of 786

>>JS: Is it the conditional promise itself that has value? Or the value that follows later that has value? RK: Both JS: You assert this, but you can not prove it.<< I disagree. As evidence to the existence of the 'value of the conditional promise itself', I have cited: .. the FASB attempt to get the the option grant value (cost, expense) into GAAP financial statements, .. the FASB success in at least getting the option grant value into the footnotes of financial statements, and .. the fact that calls on the CBOE have a non-zero positive price. To that I add: If the conditional promise itself had no value, employees would simply ignore option grants. But they don't ignore them. They can't get enough of them. Do you not believe that the FASB has intelligent people working for it? Do you not believe that the options market knows how to price options? Have you ever heard of anyone refusing a stock option grant because the grant has no value? (You yourself have used the later argument.) >>You seem to think that somebody gained actual economic value, as opposed to having gained an expectation of future economic value that hasn't actually been gained yet.<< Absolutely. Same argument as above. >>Actually Ron, in the first place, I have already referred you to the seminal paper on option valuation, which you apparently have not read. Or which you did not comprehend.<< If you mean the original work by Black-Scholes back in the early 1970s, you are incorrect in your assumption. I have read it and I comprehend it. >>JS: So where you claim that there are two values, indeed there is but one value!!! Measured as it is from two different perspectives, one of which is perfectly accurate but retrospective, and one of which is prospective but prone to error. RK: John, you've made that presentation many times .. and, as best I can recall, always without any proof .. or even a shred of corroborating opinion. JS: "OK. Try this for proof. Let's start by assuming you are correct. That is to say, that the fair value of an option is DIFFERENT than the expected future value on exercise.<< Whoa! Where did that come from? I agree with the premise that the fair value of an option IS THE SAME AS the discounted expected future value on exercise. I originally disagreed, and still disagree, with your "indeed is but one value" statement. And I see no connection between this statement and the proof you presented. "One value"? Are you elevating the employee stock option to the level of a "store of value" like .. like gold bullion? As you know, the valuation (hence, value) of an option continually changes. Market prices change, volatility changes, expiration draws nearer, etc. The employee stock option has one valuation on grant, and another valuation on exercise. Are you applying some subtle definition difference between value and the result of a valuation? If so, why are you keeping it a secret? From what you have presented, I do not understand your one value concept. Would you please try again and clarify? The proof you presented is an excellent rigorous proof. Especially since proving a basic concept is often more difficult than a more complicated proof. Your effort is commendable but, .. unfortunately, was unnecessary. Had you allowed for the possibility that my intelligence was higher than you were giving me credit for, you would have realized that most likely I understood a concept that basic. Then you might also have realized the disagreement was with your conclusion and not a premise .. and saved yourself a lot of effort. Ron

To: Stock Farmer who wrote (75)	6/19/2002 6:50:41 PM
From: rkral	Read Replies (3) \| Respond to of 786

OV = PV + EV ... Option value = promise value + exercise value ... John, the reason you believe that OV does not equal PV+EV is because you ignored the time variable. I replaced the EV term with an IV term, because I redefined the time of valuation of this term. (Note: This proof is for non-qualified stock options.) We start assuming the general equation, PV(t) = OV(t) - IV(t). The equation will be validated by showing it properly defines values at option grant and option exercise. Showing both PV(t) and IV(t) as positive non-zero values, not necessarily simultaneously, at some point during the option life will prove that the option value can be expressed as a sum of those terms. Between the grant and exercise dates: By definition, the conditional "promise value" is the option value minus the intrinsic value of the option. The employee stock option cannot be converted to cash on the open market, so the only relevant dates are the grant date and the exercise date. [For t >= grant date and t <= exercise date, PV(t) = OV(t) - IV(t) = OV(t) - (P(t) - S)] On the exercise date: The exercise value is the intrinsic value of the option. The intrinsic value is, by definition, a positive non-zero value. Thus the "promise value" equals zero, i.e., the promise value immediately before exercise, if any, is forfeited. This agrees with the stock-based employee compensation deduction reported to the IRS, resulting in a tax benefit. [When t = exercise date, OV(t) = IV(t), thus PV(t) = 0] On the grant date: The strike (exercise) price equals the stock price, making the intrinsic value of the stock option equal to zero. (This is the result of the "intrinsic value method" of SFAS 123.) Since the intrinsic value is zero, we see the value of the "conditional promise itself" is equal to the option value. This is the result of the "fair value method" of SFAS 123. This result can be shown to be a positive non-zero value. [When t = grant date, IV(t) = P(t) - S = 0, thus PV(t) = OV(t)] Therefore, PV(t) = OV(t) - IV(t) is a valid equation, and the option value can be said to be the sum of the "promise value" and the intrinsic value. QED The observant will notice the "promise value" as the time value of an option. Ron P.S. Definitions: Option Value, OV(t), current option value. Also present value of expected future difference between option strike price and stock price upon exercise. Intrinsic Value, IV(t), current difference between option strike price (S) and stock price (P(t)). Promise Value, PV(t), difference between option value and intrinsic value on current date. Neither OV, nor IV, nor PV can be a negative value.