Daughter listens to dad
pontificating about stock
options, then decides on a
better option of her own.
by Sidney Rutberg
“
H
ey, Dad, what’s all the fuss about stock options? I
thought they were supposed to help everybody that
works for a company and also benefit shareholders
since options aren’t worth anything unless the stock goes
up.”
“Well, Princess, that’s a very old-fashioned way of
looking at them. In the old days options were issued at the
price the stock was selling at the time or maybe a little
higher so it didn’t
have any value until
the stock went up.
You see, there’s no
point in exercising an
option if you can just
go out in the market
and buy the stock at
the option price. The
thing gets value when the stock price rises. So stockholders
didn’t complain because they also benefitted when the stock
price rose.”
“Sounds good to me, Dad. So, what’s the problem?”
“Well, there are lots of problems. For one thing the
accountants decided that options had to be charged as costs
based on some of the dumbest rules ever created. Since
there is no measurable costs of options, and there was a lot
of hollering about how options were diluting the number of
shares a company has outstanding, and giving a lot of
executives a free ride, the accountants decided that there
had to be a price. Since there was no realistic way to value
options, they came up with a formula that decided that stock
prices of all companies would rise over time and that value
had to be translated into costs for the issuing company.”
“But, Dad, stock prices don’t always rise, do they?”
“You certainly asked the right guy about that. I’m
sitting with a lot of Ford Motor Company and General
Motors stock that I’m still hoping to break even on, but I
certainly wouldn’t base an accounting rule on that hope.”
Sidney Rutberg is a contributing editor to
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86
“Well, Dad, let’s hope that most investors aren’t as
clueless as you are.”
“Don’t get cute, young lady. I’m trying to be serious
for a change.”
“OK, Dad, let’s get back to stock options.”
“Fine. The fuss about options now is that corporations
are messing around with the exercise price. Instead of
pricing them at the market price at the time of issue, they
are timing the issuance of
options to come just before
the company is about to
make an announcement that
will push the stock price up,
or pricing them at the
lowest price during a 30-day
period, or backdating them
or essentially trying to
guarantee that the stock price will go up quickly and the
option holders will be immediately rich.”
“Is that legal, Dad?”
“So far, the issuers have been getting away with it, but
there is now talk that pricing an option just before a bullish
announcement is tantamount to insider trading. And insider
trading is a crime.”
“Does that mean that they’re going to put somebody
in jail?”
“I don’t know, but it does make a lot of sense. Setting
the option price just before an announcement that’s going
to push the price up is really no different than finding out
from an inside source that the company is about to announce a huge increase in earnings, and buying the stock
before the announcement. You see, there are two sides to
every stock sale. There are the buyer and the seller and
when the buyer has nonpublic information that the seller
doesn’t know, then the seller is being defrauded.”
“Is that what happened in the Martha Stewart case?”
“Not really, Princess. What Martha Stewart went to
jail for was lying about having set up a stop-loss arrange(Continued on page 88)
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ment to have the stock sold when it reached a certain price.
The jury didn’t believe her story.”
“What’s a stop-loss arrangement?”
“That’s a fairly common practice by investors and
traders. The owner of the shares tells his or her broker to
sell the stock if it reaches a certain price. This is a device
to prevent the owner from just sitting by while the stock
keeps dropping, wiping out any profit the stockholder may
have had in the issue. If the gains are already wiped out, the
tactic will limit the stockholder’s loss.
“Thus, the name "stop loss." The tactic is not perfect.
It’s set up by computer so if a stock hits the sell price at
any time during the trading session, it’s sold, even if it
shoots up in the next trade and finishes the day at a new
high.”
“That doesn’t sound like such a great idea, does it
Dad?”
“Well, in most cases it does work to stop losses or
lock in gains. But it’s not foolproof.”
“So, getting back to options. Do corporations use that
dumb formula for determining their cost?”
“Some do and some don’t. Some companies have
given up on options and are giving employees stock instead.
You see, you can get a pretty good idea of the value of a
share of stock just by checking the market. You don’t have
to use higher mathematics to figure something that on the
face of it is based on a shaky premise.”
“You mean the assumption that the price of a
company’s stock will always go up.”
“Right, young lady. You seem to be really listening. I
wish your brother was that attentive. I may just give up on
him. His mind seems to be completely absorbed reading
magazines like Maxim and listening to those trashy hip-hop
records.”
“Dad, get with it. People don’t make records anymore. They make CDs or DVDs. There’s a lot more to life
than balance sheets and P & L statements. In fact, I listen to
all this boring stuff that you keep explaining because I have
nothing else to do. I think I’ll go to the mall, where they
have my kind of options.” ▲
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