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

To: Stock Farmer who wrote (81)	6/20/2002 12:53:55 AM
From: rkral	Read Replies (2) \| Respond to of 786

When I described "expected future value" I very clearly defined this as the difference between what the stock is expected to be worth in the future and the strike price. That makes no sense to me. That is the definition of option value, the fair value of the option. Why have another variable with the same definition in the same equation? Besides, I merely removed the discounting from your definition. Using the time variable makes discounting unnecessary. By inspection, we see at t = exercise date, when PV(t)=0, the result OV(t)=IV(t) is obviously correct. I think you will note that this BY DEFINITION is equal to the sum of intrinsic value plus time premium. Simply telling me that you interpret this to mean that the time premium is equal to the expected future value is in effect merely pointless twisting of semantics. I disagree .. whether you meant "this" to be OV or EV. You neither explicitly nor implicitly said anything about time value (premium). Had you considered, in connection with "promise value", that option value = time value + intrinsic value, I believe you would have realized that *OV can be the sum of two terms* .. and you would have also realized that "promise value" = time value at option grant. It appears to me that you were not aware of either. Hence, my proof. If you expect an option to be worth $5.00, and the current intrinsic value is $1.00, that makes the time premium worth $4.00. Right? Almost. I would agree with "if an option is worth $5, and the current intrinsic value is $1, that make the time premium worth $4". But I don't "expect" the option to be worth $5. The Black-Scholes option model can determine the expectation. The strike price is known. Of course, volatility, risk-free interest rate, dividends, and option life must be estimated. Using those estimates has got to more accurate than just pulling a number out of the air. Furthermore, by expecting the option to be worth $5.00 you expect the market price to be $5.00 above the [edit: strike] price. In present value terms. Right? Right .. as long as it's understood that the expectation is obtained from the Black-Scholes option model. The PV cannot be calculated in a conventional manner because the exercise date is unknown. Amazingly, the B-S option model calculates the PV without "knowing" the exercise date. Start again very simply. You write an option. You give it to me. Both of us look at it and say that we think it will be worth $5 in 5 years time. Almost. I would agree with "we think the option will be worth $5 when exercised". The actual time elapsed is irrelevant. You can jump up and down and claim that you have given me something "worth" $5.00 and so that act of generosity cost you $5.00 because you might have given it to someone else. Almost. I might have *sold* it to someone else for $5.00, so it cost me. Yes. Or you can say that since the future hasn't yet unfolded that you haven't really gained or lost anything, but that you expect to lose $5.00 in the future. I already lost the $5.00 as soon as I gave the option to you. *STILL TRYING TO DECIDE WHAT IS REAL UPON EXERCISE* ***** JUST PLAYING A GAME WITH THE FOLLOWING ***** I don't care what happens in the future (as far as the option cost is concerned). Remember, I'm not a normal option writer. I'm a company. I just print a share. The question I have for you is, looking backwards from the point of exercise, what did this option ACTUALLY cost you? A measely $5.00? Or the full $20? How do you answer? The measly $5. Stock price goes way up? I just print a share. And the higher it goes, the better I like it. The U.S. Congress, in writing its tax codes, has seen fit to give me a tax credit based on the intrinsic value. The higher the stock .. the greater the tax credit. No skin off my nose. GO STOCK! More important, how do you ACCOUNT for this deviation from expectation? I don't. It doesn't increase my cost! It just increases my tax credit. Ron