My Stock Options are Worthless!
My Stock Options are Worthless! - 8 Apr 2009 - Advisor David Gratke's Blog
Are you sure about that?
Because of the bear market, many stock options appear worthless since the exercise price is above the stock's current market price. Sure, you can't cash the option in today. But it still may have value - if you have the luxury of time.
Compute, Analyze, Model, Manage
According to Equilar, a leading compensation consulting firm, more than 70 percent of the nation's largest companies recently had options with exercise prices above the market. These grants should have been exercised "in the money" if only the optionee had known when to take action. But even stock options like these shouldn't necessarily be discarded.
We think we can clear up the confusion.
From our ‘virtual' toolbox at David Gratke Wealth Advisors, LLC, we can analyze the value of your employee stock options. Factors to consider include price volatility of the underlying shares as well as changes in interest rates to name a few. In the process, we'll discuss decision points based on your personal goals.
Welcome To StockOpter.com
We use StockOpter.com (SO) to help you monitor the intrinsic and potential values of your stock options. SO enables us to alert you so that you may make profitable decisions when those values change, as we know those values will change.
Important alerts are sent by email, notifying us of critical changes in values including stock price, risk/reward ratios, the level of employer stock and options concentration, and deadlines such as upcoming vesting dates, option expiration dates.
Use It Or Lose It
There are several unique attributes to SO, but two stand out. The first is "Forfeit Value." If you walk away from your job, what equity compensation value is left on the table?
This calculation is valuable to employers, too. In this economic environment, how easy would it be for a would-be employer to say, "hey you have no value in your options where you are, why don't you come to work for us?"
But wait just one minute. By analyzing the Forfeit Value, which often can be a considerable sum, we can fully illustrate the present value of your options. Yes, your options may still have value, even though they appear under water.
Hold Or Exercise?
The second key concept of SO is what we call the "Insight Ratio" This calculation can be used to determine whether it makes sense to continue to hold the option or to exercise it now.
For example, an Insight Ratio of 10% means that 90% of the option's value is "in the money" and subject to loss should the stock price decline. Simply put, the current value of the options equates to high risk and low future potential gains: 10% possible upside verses a possible 90% downside.
An Insight Ratio of 90% by contrast, would mean that 90% of the option's theoretical value will not be realized if exercised today. The current value of the options equates to low risk and high future potential gains: 90% possible upside verses a 10% downside.
Contact Us
If you have stock options, StockOpter is an important tool - especially in the current market environment. For a consultation, please contact David Gratke of David Gratke Wealth Advisors, LLC, Portland, OR to begin the discovery process together.
When it comes to underwater options, the only financial measure that makes any difference is 1) How much would a successor employer compensate the employee for giving up underwater options divided by 2) How much retention value the employee places on them. In most rational circumstances the result approaches zero.
If underwater options were truly worthless then employees would gladly give them back to the company. We're not seeing this; in fact many plan participants are electing not to participate in exchange programs. A fixed exercise price and a future expiration date provide options with "Time Value" that can be calculated with various methodologies. Time Value won't buy anything at Starbucks, but it is a factor that should be considered when making decisions regarding stock options. Additionally, it is in a company's best interest to make sure their stock plan participants understand the concept of Time Value because it conveys that recent stock value decreases are likely to recover over time. Right now companies need to promote confidence in their equity compensation programs and that's difficult when employees perceive their stock options to be worthless. Perception is reality, but perceptions can be changed with a little "timely" information.
I think this is a very interesting discussion that should be explored further.
Valuation experts will give you a potential value on a stock option at any point in its life. As the option falls out of the money and as it gets closer to its expiration date the value falls and can effectively become worthless.
Option holders can get an option and have an expectation of value. This expecatation can be based on nearly anything. Past experiences; media sotries; hopes and dreams; their neighbors new car; etc.
As valuation experts see their values become incorrect they simply recalculate and give a new value. Little emphasis is placed on the fact that the old value was often incredibly wrong.
As Option holders see their values become incorrect they react with a wide array of interesting responses. If the value has gone up then this becomes something of an expectation, or floor, value. If the value drops some react with an irrational response of almost instant zero value. Others react with a response of "the value will come back". Others decide their initial decision to hold any value in equity was flawed and want a replacement in something more immediately tangible.
As professionals how do you deal with each of these circumstances? How do you reconcile the constant moving values and expectations? It would be great to hear from ECE members regarding this specific issue.
Many employees feel with the volitility of the market a stock option granted at $20 and was trading at $30 before it dropped could be at $30 again soon so the real decision is do I give up a large number of shares for fewer "in the money" shares with new vesting in an exhange or since I am not going anywhere soon do I wait until the shares are in the money. Many employees are not particpating because they are committed to their employer for the long haul and not willing to give up possible large long term gains for shorter term gains.
Despite all the financial modeling, at the end of the day, the employee decides whether their stock options are worthless - even when they are "in the money". Why? They're worthless once the employee believes that either: he/she can't cash them in anytime soon or they leave their current employer for a better opportunity (which happens, as we all know, even if their is some value to them).
Financial models right now at best (if we're honest with ourselves), provide a foggy outlook and if the ongoing financial downturn is any indication, nothing more than throwing a dart at a dartboard in the dark.
Pretty subjective really and in the final analysis, the employee decides if they have any value or not - period. No pep talk for someone in HR is going to fix that. Employees aren't necessarily "repricing" or surrendering their options because they want to "stick it out" with their current employer but because they have no where else to go - yet.
The market will recover eventually and employment demand will again be on the upswing but I don't think stock prices will recover as quickly to bring all the underwater options out there back in the money. It will be interesting to see how that dynamic plays out.
I think everyone has a point.
Perception is reality in the case of equity compensation. If someone believes their options to be worthless then they are.
The question can we modify that perception?
Is it right for us to modify that perception?
Do we risk future credibility by explaining potential value?
Do we risk staff by not explain it?
Do we punish our shareholder by repricing before communcating?
Do we punish shareholders because we are not good at communicating these programs to shareholders?
Let's not forget the other business reasons of reducing dilution and increasing shareholder value by retiring the shares exchanged in addition to key talent retention.