A Wall Street Journal Online article discussing ESOs

Thanks posting this link John,

I think this would be a great reading for anyone involved equity compensation programs.

Dan

I agree this is a great article.  In addition to mentioning hedging strategies it also advocates making informed decisions for "Spreading the Risk" by diversifying concentrated positions and "Maximizing Option" values by calculating the percentage of "time value" to "intrinsic value" (Insight Ratio).  

A couple of questions about items discussed in the article (I'm an academic, so have to ask questions).

1. Is the exercise when time value equals one-third or less of option value a widely used heuristic?

2. How common is the use of collars and put options in your opinion?  I would assume that most companies prohibit these for officers and directors?

Thanks

We have a platform (www.stockopter.com) that calculates the ratio of time-value to intrinsic value.  We are the only company that provides this service.  It is available to financial advisors and stock plan participants alike.  Between the two groups there are probably less than 5,000 cases being run per year using StockOpter.com out of 9 million option holders.  There also may be a few individuals and companies that manually calculate this ratio themselves.  So to answer your question, no this is not a widely used heuristic, but it shoud be.

As for the second question, I would defer to John Olagues because he's been a big advocate of using option hedging strategies.  In my opinion, it isn't very common but that's not just because of company policy.  It is because these strategies are complex and employees aren't being educated on the time-value concept of options which is necessary to understand how to use market traded options to hedge employee stock option positions.

Just my 2 cents......

Dear Steve:

Bill's firm offers a good service as it helps the holder of employee stock options to understand what he/she has and the values of the two components (i.e. intrinsic value and "time value") of the ESOs. Then they provide a system where the holder can make an accurate assessment of when to exercise.

My advice is to try to hold the ESOs longer, unless you need the money or your positions are too small to worry about the consequences of premature exercise.

Companies generally do not prohibit selling calls or buying puts in the contract documents, although some companies insert a seeming prohibition in Insider Trader Policies.

The best strategy in my view is hold the ESOs until they vest and rise above the exercise price. Then sell slightly out-of-the-money calls or at-the-money calls on a  part of your position. if the stock goes higher, sell more calls and do the same over time. This will reduce risk and even generate income.

I would seldom advise doing collars because the out-of-the-money calls are often under priced and the out-of-the-money puts are generally over priced.

The expected results of partial sales of calls are better than early exercise, sell, and diversify, which have high penalties and defeats the purpose of the grant by eliminating the alignment of interests.

John Olagues