Re: establishmentarian whining

[Sabri Oncu <sabri_oncu@xxxxxxxxxxxxx>]

> On the issue of valuing stock options:  Can't
> they just apply Myron Scholes' formula?
>
> Gene

Greetings from Ankara Gene,

I don't know if anyone answered this but here is my answer. It is not appropriate to use the Black&Scholes formurmula for the employee stock options.

Firstly, Black&Scholes results are applicable to "plain vanilla" European call and put options and the formula for the European call options also applies to the American call options because of an optimal exercise argument. Since such an argument is not valid for American put options, we have no formula for American puts and hence such options should be priced using some numerical method.

As for the employee stock options the situation is much more complicated than the American puts.

Firstly, these are "perpetual" options in the sense that there is no set exercise date. After the vesting period ends, you can choose to exercise them at any time from there till eternity, provided of course that you and the firm remain alive till eternity.

Secondly, because of the vesting periods and provisions such options are indeed a portfolio of options, each of which has to be valued separately. For example, you may be given 1,000 options under the condition that only 200 of them are vested the first year, 200 the next year so forth. This means you are given a portfolio of five options, each of which is "perpetual" American call options with varying vesting, or better said, call-protection periods.

Clearly, this animal is quite different than the "plain vanilla" American call options to which the Black&Scholes call formula applies.

A further comlication is that the firms can fire employees as they wish and employees can leave their firm if they so choose. Since such options are non-transferrable, they go worthless when either of this happens. One way to look at this is that embedded in these options are the firing option the firm holds and the leaving option the employee hold.

To sum up, what we are looking at is an other-options-embedded call-protected "perpetual" American call option, which is a very difficult animal to price. Looked at from the point of view of the firm, you need to price a large porfolio such options issued at different times with different exercise prices and call-protection periods and so-forth and the task becomes much more difficult.

I can give you more reasons but the above reasons should suffice.

Best,

Sabr}


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