Saturday, December 03, 2005

Employee Stock Options - Part 1

So... I just sold some of my employee stock options (non-qualified). They don't expire for 5+ years. I know, I know... you aren't supposed to sell NQ options until they expire.


My company's stock, however, has really ran-up in the past 12 months and the exercise value of my shares is now a material portion of my portfolio. One of my buddies and I came up with an interesting ratio to simply evaluate employee options:

The Early Riser Stock Option Valuation Ratio (or TERSOR for short)

TERSOR = Current Stock Price / (Current Stock Price - Strike Price)

This ratio tells you how much better an alternate investment must return as compared to your employer's stock. A few examples may help:

Stock Price = $50 Strike Price = $25
TERSOR = 50 / (50-25) = 2 or 200%
This tells you that your alternate investment must have a return that is double your company's stock return going forward. So if I expect my company's stock to return 5% per year and I can get 12% (or 240% of my company's return) in the market, I should seriously consider selling my options.

Stock Price = $26 Strike Price = $25
TERSOR = 26 / (26-25) = 26 or 2600%
Now my alternate investment would need to return 26 times my company's return to equal the potential appreciation of the options.

The key idea here is that options (when the strike price is very close to the market price) are leveraged investments. This leverage decreases, however, as the market price rises.

Volatility is a big issue when you evaluate your options. This will be discussed in Part 2.

4 Comments:

At 9:26 AM, Blogger Ironman said...

Political Calculations has built a tool to do this math!

 
At 9:45 AM, Blogger Early Riser said...

Thanks ironman! It really feels good to know people are actually reading my blog. Maybe you can look at part 2 & 3 and build some more complex tools.

 
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At 12:53 PM, Anonymous PENNY STOCK INVESTMENTS said...

Theirs will always be stock options.

 

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