Silicon Investor (SI) -- The First Internet Community

STOCKTALK

We've detected that you're using an ad content blocking browser plug-in or feature. Ads provide a critical source of revenue to the continued operation of Silicon Investor. We ask that you disable ad blocking while on Silicon Investor in the best interests of our community. If you are not using an ad blocker but are still receiving this message, make sure your browser's tracking protection is set to the 'standard' level.

Technology Stocks : Cisco Systems, Inc. (CSCO) -- Ignore unavailable to you. Want to Upgrade?

To: Lizzie Tudor who wrote (64152)	6/1/2003 2:14:06 PM
From: GVTucker	Read Replies (1) \| Respond to of 77400

"Risk premium" is not part of the Black Scholes equation. Volatility in this case means just that--volatility. Most people that use Black Scholes make the assumption that the recent volatility will be roughly equal to future volatility. Sometimes that is valid, sometimes it isn't. But that has nothing to do with risk premium, which is related to expected return.

To: Lizzie Tudor who wrote (64152)	6/6/2003 8:17:20 AM
From: rkral	Read Replies (1) \| Respond to of 77400

OT .. re "That means that I equate risk premium to be almost entirely volitility." Gee Lizzie, that's why I asked "Are you maybe referring to volatility?" .. in my opening post to you. Why did you first provide irrelevant links? When the employee "buys" an ATM call option valued with Black-Scholes option valuation model ("Model"), the employee is accepting three risks ... 1) Probability Risk -- The stock price may remain at, or below, the exercise price, 2) Volatility Risk -- The price volatility may be less that assumed for the Model. If so, the employee paid too much for the option, 3) Interest-rate Risk -- The risk-free interest rate may be less than assumed for the Model. If so, the employee overpaid. Now to call the impact of either volatility or interest-rate risk on the option value "risk premium" .. is a misuse of the term IMHO. Traditionally, *risk premium* is the additional return a rational investor expects for assuming additional risk. IOW, the expected future value is discounted by the risk. The greater the perceived risk, the greater the discount, and *the lesser the price. On the other hand, a greater stock price volatility* increases the probability a call option will be exercised. This increased risk is incurred by the call writer, who demands a greater option premium. Hence, the greater the perceived risk, *the greater the price. See the difference? But being quite sure what you meant, I didn't really care what you called it, until you wrote "well the real issue as far as expenses on a new IPO imo isn't really the amt of the grant but the risk premium, which is probably an infinite number". (#reply-18990151) Then I wasn't sure any more. You see, stock prices don't become infinite, which means volatility doesn't become infinite, which means option values don't become infinite. Hmmm. "Lizzie must be talking about something else", I thought. So I asked what you meant, but you weren't talking about something else .. apparently. Now assume a company grants an NQSO at an exercise price of $15 (when the stock price is also $15). How great would the Black-Scholes option value be .. if the volatility actually was* infinity? Could it exceed $15? Regards, Ron