Sally Jameson Stock Options Essay Sample
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1. Describe. in general footings. Sally’s Executive Stock Option determination. You should acknowledge this as an NPV job that compares alternate hereafter hard currency flows. What is the NPV of the hard currency option? The hard currency option being referred to here is the Telstar Communications option tranche on offer. the present value of which needs to be compared with that of the hard currency option. • • PV [ Cash Option ] : $ 5. 000. 000 PV [ Stock Options ] : $ 11. 724. 000 • Calculated utilizing Black Scholes Option Valuation Model ( attack / methodological analysis follows )
2. Describe Sally’s ESOs in footings of the parametric quantities which would be input into an option pricing theoretical account. Which option pricing theoretical account is appropriate? • Sally is being offered 3. 000 options to buy Telstar Communications portions at $ 35. 000 on her 5th day of remembrance with the house. In other words. Sally is being granted the right to. but non the duty to. buy these portions on ( non earlier ) her 5th day of remembrance with Telstar. Since Sally can non exert her options before five old ages with the house. these are European options. which can be valued utilizing the Black Scholes Options Valuation Model. The Black Scholes Options Valuation Model requires the undermentioned input parametric quantities: • Current Stock Price: $ 18. 750 • Call Option Strike Price: $ 35. 000 • Time to Maturity ( old ages ) : 5. 000 • Annual Interest Rate: On May 27 1992. exchequer security outputs on 5-Year T-Bills was 6. 02 % – the hazard free rate on five twelvemonth securities can hence be modeled with certainty. • Given the handiness of current Telstar call option monetary values. the implied volatility required for the computation of the value of Sally’s ESO can besides be estimated ( see following response ) . • As stated in the instance. it can besides be assumed with comparative certainty that Telstar would non pay a dividend on its stock over the five twelvemonth skyline in consideration i. e. the mean dividend can be assumed to be 0.
3. In peculiar. measure the inquiry of Telstar’s stock monetary value volatility. Using the Black Scholes Calculator. find what volatility estimate the market is utilizing to monetary value the publically traded Telstar options. For what periods of clip are these volatilities implied? What factors are of import in finding the volatility estimation to utilize in valuing Sally’s ESOs? In your opinion. what value of volatility should be used to value the ESOs? Given the fact that the stock options being offered to Sally are long-run options. it makes sense to utilize monetary values refering to the long-run publicly-traded Telstar call options. Long-run Telstar Call Options are priced as follows on January 22nd. 1994. Strike Price $ 12. 50 $ 17. 50 $ 20. 00 22-Jan-94 $ 7. 750 $ 4. 625 $ 3. 750
Given this information. the implied volatility in each can be calculated ( utilizing the Black Scholes Calculator ) to be as follows. Strike Price $ 12. 50 $ 17. 50 $ 20. 00 Average 22-Jan-94 35. 220 % 34. 920 % 37. 560 % 35. 900 %
The implied volatility pertains to the period 1year. 7 months and 26 yearss ( May 27. 1992 – Jan 22. 1994 ) The factors of import in finding the implied volatilities tabulated above include the current stock monetary value. the call option work stoppage monetary value. the clip to adulthood of the option in consideration. the approximative involvement rate associated with that period and the false dividend output. As can be seen in the tabular array above. the mean volatility implied in the monetary values at which long-run Telstar call options are merchandising is 35. 900 % . This is the estimated volatility I intend to utilize in my computation of Sally’s stock options.
4. What is your estimation of the value of Sally’s ESO bundle? If you were to take the options and chance on the stock monetary value traveling frontward. what per centum of the clip do you believe you would do more than what Black Scholes calculates? CALL OPTIONS: Telstar Communications S: Stock Price ( $ ) $ 18. 75000 Ten: Strike or Exercise Price ( $ ) $ 35. 00000 Thymine: Time to Maturity ( old ages ) 5. 00000 R: Annual Interest Rate 0. 06020 s: Annual Standard Deviation 0. 35900 vitamin D: Asset Yield –
Entering the above parametric quantities into the Black Scholes Calculator outputs an option monetary value of $ 3. 908 for the ESOs being offered to Sally. Assuming the Black Scholes Option Valuation Model provides the average rating from a distribution of every bit likely monetary value waies. I would conceive of that I would do more than what Black Scholes calculates half the clip. and less half the clip.
5. What should Sally make? Why? • • • • Cash being offered: $ 5000. 000 Value of Executive Stock Options: $ 3. 908 ten 3. 000 = $ 11. 724. 000 It therefore appears that the value of the ESOs being offered to Sally is more than twice the value of the hard currency being offered to her. Having said that. it’s worthwhile observing that there’s a difference in hazard being undertaken in each instance: • There is no hazard associated with choosing for the hard currency option. • Choosing for the ESOs is capable to put on the line – it’s possible that her options will be worthless at the clip of exercising. Furthermore. Sally may desire to go forth the company before five old ages with it. in which instance she would lose her options. I would urge that Sally take the stock options given their much higher rating. every bit long as her hazard appetency allows for the gamble.
