These attached Bar Graphs illustrate how the theoretical

values of the employee stock options change under different

assumptions and price movements.

These graphs also illustrate what happens when the options

are exercised prematurely and the stock sold.

In these graphs, we assume that the stock price on grant day

was $20.00, giving the options an exercise price of $20.00.

The nominal expiration day is 10 years from the grant day.

But the times to expiration are discounted to get the

"expected" time to expiration.

At grant day, the assumed expected expirations are 6.5 years

and 6.3 years respectively.

The assumed volatility and interest rate are different

(30 and 5%) and (60 and 3%) respectively.

The assumed expected dividend is "0" in each case.

The graphs show how the "time premium" changes as the

underlying stock price changes and time to expiration

decreases. The graphs with the higher assumed volatility

shows higher "time premiums", especially

with the stock around $20.

The "time premium" equals the difference between the

intrinsic value and the theoretical value. The "time premium"

is the amount that is forfeited upon early exercise of

the options.

The Purple Tax areas show the approximate amount that the

executive must pay in taxes when the exercise and sale of

stock is made.

The green Net Proceeds area shows the amount that the

employee/executive will receive net after tax if he sells

the stock or holds on to the stock.

The net after tax proceeds are less than half the

theoretical value with the stock at 40 with 4.5 expected yrs.

So if the employee/executive exercises when the stock

is 100% above the exercise price, he nets less than half

(i.e. 45% and 49% respectively) of the theoretical value in

both cases. If the assumed volatility was substantially less or

the time remaining was less, the net would be closer to 60%.

Theoretical Value = Time Premium + Tax liability + Net Take

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John Olagues

The author, JOHN OLAGUES, is a former member of the Chicago Board Options Exchange and the Pacific Stock Exchange for over ten years. He offers a unique view of employee stock options from a trader’s standpoint rather than from the standpoint of an accountant, compensation planner or academic. To contact JOHN OLAGUES email olagues@hotmail.com and  see www.optionsforemployees.com.