Replies

Figuring the value of options is indeed very simple. There are at least 60 acceptable price models. Categorizing the issue of out-of-the-money options as an expense is ludricrous, though. Why?

Take a company. On July 15th, it has no outstanding executive options. Its share price is $20. On July 16th, it issues EOs to the extent of 100,000 shares, exercisable at $40 within five years. Using a popular option model (modified B-S-M, if you care) and observing the 5-year volatility of the share price to be 30%, we compute the theoretical fair value of the options, which turns out to be $1.80/share.

Are you claiming that the company has, in one day, incurred an 'expense' of $180,000? At the moment, the company's expense is entirely the cost of entering the options onto their books, call it 1 man-hour.

This is every bit as silly a viewpoint as when the Clintonoids tried to tax homeowners on non-existent 'imputed rent'. How have earnings changed? They haven't, not by a penny. There are already far too many bookkeeping fictions floating around, let's not add one more.

N.B. Now, if the options issued were IN-the-money, that's an entirely different matter.

Take a company. On July 15th, it has no outstanding executive options. Its share price is $20. On July 16th, it issues EOs to the extent of 100,000 shares, exercisable at $40 within five years.

This is not the way ISO's or NQSO's are granted or work.

There is no 'exercise price' written into the grant. The exercise price is whatever the stock trades at on the day the option is exercised, as per the vesting schedule and the holder's decision to exercise. Depending on the option type, the exercise price affects the companies tax position. Also, depending on option type, both the exercise price and the sale price (if and only if stock is also sold) affects the individuals tax position.

Other 'performance clauses' may exist in employment contracts that peg compensation to stock price, e.g. 'bonus of additional 1M shares when stock price exceeds $40 for a 1 year period'...but again that is not part of a stock option.

ISO's and NQSO's have a only grant price which must be within 85% of the FMV on the day the option is granted. The exercise price floats with the market but years into the future as per the vesting schedule. That's why they can't be reliably estimated.

If the future FMV of a stock could be reliably estimated for accounting purposes, we'd all get rich 'knowing' what the future price of any given stock would be. But it can't and we won't.