18 May Financial Derivatives
This project deals with the Harvard Business School options case “Sally Jameson: Valuing Stock Options in a Compensation Package (Abridged).” The case details a thinly disguised situation faced by a recent Harvard MBA graduate, Sally Jameson, who was forced by a prospective employer Telstar to place a dollar value on a grant of stock options. Sally must choose between a $5,000 cash bonus, or 3,000 options to buy Telstar stock at $35.00 per share at her fifth anniversary with the firm. One option allows Sally to buy one share of Telstar.
Q#1. Find out the approximate historical average, lowest, and highest volatility from the Telstar’s volatility graph in Exhibit 3. If we ignore the tax considerations and assume that Sally will stay with Telstar for at least five years, what is the value of the 3,000 stock options at the average, lowest, and highest volatility based on the Black-Scholes option pricing model? The option’s expiration date will be five years if Sally’s tenure with Telstar is at least five years. Which compensation package, cash vs. stock options, is worth more to Sally? Which one would you recommend to Sally?
Q#2. If Sally’s probability of leaving Telstar before five years is 50%, what is be expected value of stock options to Sally under the average, lowest, and highest volatility? Which compensation package, cash vs. stock options, is worth more now to Sally? Which one would you recommend to Sally?
Q#3. What if Ms. Jameson decided that the option was a better deal, but she didn’t want all of her financial wealth (as well as her human capital or job) tied to the fortunes of Telstra. Assuming she works at Telstar for at least 5 years and accepts the option grant, what option strategies she can employ to protect the value of her stock options? You can assume that both long-term call and put options on Telstar with maturity up to 6 years are currently traded.
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