Jordan Hayes jmhayes at j-o-r-d-a-n.com
Sun Mar 12 17:22:57 PST 2000

From enrique at ee.cornell.edu Sun Mar 12 14:17:16 2000

On the other hand, if you can show that B-S significantly

overestimates the value of options, that'd probably put

you in the running for the Nobel prize.

Well, a few points:

* BS just gives you a theoretical price _at the moment you calculate_

so it says nothing about the value of that option in the future.

They fluctuate as the underlying and interest rates fluctuate.

So trying to use BS to pick a point in time that you "know" what

they are "worth" is a fruitless exercise. Dragging BS into this

discussion makes me think you don't actually understand how

options work ...

* BS _always_ gives you a price that is lower than someone would

actually do a trade with you for. This is due to several items,

not the least of which is that there is often a supply and demand

component to the markets you'd want to buy them in. There's

also a spread to worry about.

* BS presumes lognormal returns on stock. Useful in theory, not

so useful for what you're looking to do.

* The breakthrough work on options pricing theory would be to

explain the difference between historical volatility and implied

volatility, which of course would be like predicting the weather


Company X can issue option Y to an employee. Or it can buy

option Y on the market, at something near B-S price, and

give it to the employee. Both cases are equivalent, from

the point of view of the shareholder.

Not really. Employee options typically don't expire; you can leave before vesting, or they can be perenially out of the money, but both of those still mean you don't have a "time to expiration" variable. Therefore, you simply cannot use Black-Scholes to value them. Also, employee options are typically not covered by stock that is in the public float. Finally, an employee can't sell their options on the open market; they are captive owners. So it's totally different.

The real question is how does the cost of exercised stock to the company compare to the deferred *forever* compensation?

Yet, in the first case, the company gets to pretend the

transaction not only is costless *now*, but it may actually

increase future earnings, thanks to the tax deduction. In

the other, the full cost of the option is deducted. Why?

Becuase they are radically different scenarios?

Are you just saying that accounting is tricky?

But the absolutely *should* be expensed at some point,

since they burn cash.

But issuing the stock in the first place wasn't income; buying it back shouldn't be an expense.

And that would make most NASDAQ companies look much worse

than they do now.

It just bums you out that investors don't understand the dilutative effect that options have on a stock? It's in the financials pretty clearly. They'd also be much worse off if their margins were lower, or if they didn't sell as much, or if they overpaid their suppliers ...


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