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PERSONAL OPTION PROFILE REPORT - SAMPLEI. ESO Portfolio Value for Sally Sample This section summarizes your current option holdings in BUD and is divided into 3 sections, each of which look at the current value of your stock option portfolio in a slightly different way. The three valuation methods are: 1) In-the-money value, 2) Cash-out value, and 3) Black-Scholes value and its related time value. In-The-Money ValueThe table below shows the gross value (before tax) you would realize from exercising and selling your options, or the difference between the current “fair market value” (FMV) per share (the current stock price) and your exercise price times the number of options. This amount is called the “in the money” (ITM) value or “intrinsic” value. The table shows this value for both vested and unvested options. You cannot realize the value from your unvested options until they vest.
Cash-Out Value of Vested OptionsThe table below estimates what you can realize from your vested options at the given FMV. The “Potential Tax” column is determined from your estimated marginal income tax rate shown in Appendix A. Your “cash-out” value for each vested grant is determined by subtracting your potential tax burden from your ITM value. The cash-out value for any vested Incentive Stock Options (ISOs) is computed as if they are sold at the time of exercise.
Black-Scholes / Time Value of All OptionsThe Black-Scholes value (BSV) is the most widely used formula for determining the price of market traded stock options. Even though this formula was not designed specifically for employee stock options, Black-Scholes is still a valuable tool for illustrating the value of your ESOs. In order to understand the workings of this formula, let’s look at the key elements of a stock option and their importance in establishing the price or value of the option.
Even options that are “under-water” will have a Black-Scholes value, because there is a possibility that the stock price will rise above the strike price of the option prior to its expiration. For options that are “in-the-money”, the Black-Scholes value will usually exceed the ITM value because the upside potential is greater than the downside risk. The difference between the Black-Scholes value and the ITM value is referred to as the “time value” of the option. The time value is a measure of the benefit expected, on average, from holding the option until maturity rather than exercising it now. It has the following characteristics:
Time value is an important metric in determining when to exercise options. This is because, as the time value decreases, so does the value of holding the option. In-the-money options with a low time value may be good candidates for diversification. The table below calculates the Black-Scholes values and time values for your stock options assuming a volatility of: 32.0%
II. Investment Risk/Reward for Sally Sample The day an option is granted, and up until it vests, you may watch changes in its In The Money (ITM) value and Black-Scholes value (BSV) with great interest, but you have no exercise decisions to make. This all changes, however, when the option vests and it is “in the money”. Since you can now realize or lose the ITM value, you are truly at risk by this amount. Thus, it becomes much more important to actively manage your option portfolio when you have vested options that are “in the money”. The following table shows the ITM value, the BSV, and cash-out values of both your vested and unvested options for hypothetical stock prices that are illustrated in 20% increments above and below the current fair market value (FMV). The row without an increment shows the current FMV. The Incremental Change is the percent that each value calculation is above or below the prior level. This quantifies the risk/reward leverage inherent in your option portfolio. Note that this risk/reward information is solely related to the options without regard to your overall net worth and the importance that the options hold for meeting your financial goals.
Depending on the details of your options, a 20% change in your company’s stock price can result in a significantly higher percentage gain or loss in your option portfolio. This is due to the leverage in the options. Also worth noting is the fact that, generally speaking, as the FMV of the stock rises further above the strike prices of your various option holdings, the relative percentage change of the option portfolio grows increasingly similar to the percentage change in the stock value. This trend represents the declining leverage of the option portfolio as the cost of exercising becomes a smaller percentage of the value of the stock. III. Personal Risk/Reward for Sally Sample Freedom Fund AnalysisNow that you have a better understanding of the value of your options and the risk/reward inherent in them, our focus turns to the role your options play in achieving your financial goals. Financial freedom is achieved when you have secured, in a low risk investment portfolio, the amount of money required to meet the needs of you and your family. We refer to this as your Freedom Fund Goal. If your Freedom Fund Goal is already secured, then you can afford to take more risk with your options (like holding them until expiration). On the other hand, if your Freedom Fund Goal is not secured, and particularly if you are approaching retirement, you may want to secure the intrinsic value of your options. Based on input you have provided, the following chart shows the status of your Freedom Fund in relation to your company stock and option holdings. The two horizontal lines are respectively your Freedom Fund Goal and the Value of your Diversified Portfolio (VDP). For this analysis, your VDP value does not change as a function of your company stock price, although one would expect that there would be some correlation in the real world between your company’s stock price and the value of your diversified portfolio. The line titled “VDP + Vested Holdings” adds the “cash out” value of your held company shares and vested options to the Value of your Diversified Portfolio. This line is plotted against various prices of your company stock both above and below the current price, which is denoted by the vertical line. The line titled “VDP + Vested + Unvested Holdings” plots incremental cash-out value of unvested options and restricted stock at various prices of the company stock.
From this analysis, your Freedom Fund Goal has not yet been met even if all of your options were vested and you were to diversify them at the current fair market value of the stock. Concentrated Position AnalysisEven if your Freedom Fund Goal has been reached, you may still be at risk if your total portfolio is highly concentrated in company stock and options. The chart below shows the asset allocation of the Value of your Diversified Portfolio, the cash-out values of your vested and unvested options and restricted stock, and the cash-out value of your BUD stock holdings. The relationship between your cash-out values and the Value of your Diversified Portfolio represents the degree to which your wealth is concentrated in your company stock. If you are in a highly concentrated position, declines in your company’s stock price can have a devastating impact on your total wealth.
Value at Risk AnalysisIn an attempt to further identify and convey the risk in your company stock and option position, we have adopted the Value at Risk (VaR) methodology used by many financial institutions to determine their exposure to negative economic events. VaR is computed using the same volatility used in the Black-Scholes calculations. Using this methodology, under normal market conditions there is a 5% chance that you could lose $794,316 or more of the total in-the-money value of your company stock and vested options of $4,214,663 during the next 30 days. Please pay close attention to the phrasing “under normal conditions” and “or more”. VaR methodology generally cannot provide an estimate for the size of losses in those scenarios where the VaR threshold is exceeded. It is possible that you could lose the entire cash-out value of your vested, in-the-money options and stock. IV. Portfolio Monitoring for Sally Sample Your options have a number of moving parts that can change rapidly and dramatically affect the value of your holdings. These variables include: your company’s stock price, your Freedom Fund status, future vesting events, expiration events, and key ratios. Consequently, it is critically important that we monitor these factors so you can take action on a timely basis. This section reviews the various factors that we will monitor and discusses the tracking criteria that you can use. The Stock PriceThe price of your stock is only one of several key factors that need to be monitored on an ongoing basis. There are a variety of ways that we can watch your stock price. You can choose a lower limit, an upper limit or a price range. The key here is to establish a target price or range that is linked to your goals and causes you to take action. Freedom Fund PercentageYour Freedom Fund Percentage is another important value to monitor because it indicates where you currently stand in achieving your overall financial goal. This percentage is calculated by dividing your Total Cash-Out Value plus the Value of your Diversified Portfolio by your Freedom Fund Goal. As an example, you may want to set this percentage at greater than or equal to 90% to alert you of the proximity of your goal. Similarly, if your Freedom Fund Percentage is already at 125%, you may want to set this trigger at 110% so timely action can be taken to secure your Freedom Fund should the company stock price drop. The ratio of your Total Cash-Out Value plus the Value of your Diversified Portfolio of $3,990,707 to your Freedom Fund Goal of $5,086,131 is currently: 78.46% Future VestingFor planning purposes, it is useful to know when your unvested options or restricted stock will vest giving you the opportunity to exercise and/or sell. You may want to set a trigger to alert you in advance (e.g. 30 days) of vesting events so you can consider timely action. The table below shows vesting by month through the end of next year and annually thereafter.
Expiration DatesExpiration dates are one of the most critical events to monitor. As expiration approaches, the leverage of your option declines and your planning alternatives diminish substantially. If you wait until the last minute and your stock declines before you take action, you may lose the opportunity for substantial wealth accumulation. It may be wise to consider a phased diversification strategy several years prior to expiration. The expiration dates for your grants are listed in the first section of this report.Key Monitoring Ratios:
Key Ratio ConsiderationsYour planning horizon and risk profile need to be taken into consideration when reviewing your key monitoring ratios. Upcoming cash flow needs are a good indicator of ones planning horizon and risk profile. The more time you have before you need to fund major expenses such as retirement or college, the longer you can wait prior to taking action on your stock options. The table below shows some general rules of thumb for how to interpret your key rations.
Next Steps for Sally Sample Your Personal Option Profile has hopefully helped you to better understand the value and dynamics of your employee stock option portfolio. Your next steps will involve a series of decisions regarding exercising your vested options and diversifying your held shares. These decisions involve judgments on the risk and reward characteristics of options and the importance of your option wealth to your overall financial goals. For your options that are currently in the money and vested, every day that you do not exercise represents an implicit decision on your part. Some reasons to exercise prior to expiration include:
I would be pleased to assist you to understand and analyze the many complex issues involved in making informed decisions regarding your employee stock options. To get us started I would like to propose the following plan of action:
Disclosures Your Personal Option Profile is based on input you have provided. This analysis has been created from your assumptions (Appendix A) and grant data (Appendix B). You are responsible for the accuracy of this report and you should not base your decisions solely on this analysis. This report is for illustration purposes only. Nothing contained in your Personal Option Profile should be construed as investment recommendations or advice. The financial calculations provided herein are to help you understand the value, risk and potential of your stock option portfolio. Past performance of your stock is no guarantee of future results. The values and risks illustrated in your Personal Option Profile in no way represents a guarantee that the portfolio will produce a particular result. The Black-Scholes values (BSV) and the time values were calculated using an estimated volatility for BUD to illustrate its potential value. There is no guarantee that this valuation methodology accurately illustrates the value of your employee stock options. Any estimate of the future volatility of a stock price is quite uncertain. In addition, there are some inherent limitations when using BSV to calculate the value of employee stock options. Specifically, BSV makes the following assumptions, which may not be appropriate for employee stock options and may indicate a need to adjust the calculated BSV:
Because of these limitations, the BSV may overstate the actual value of the employee stock option. To adjust for this over-valuation, it may be appropriate to consider discounting the BSV to reflect the restrictions inherent to employee stock options. Appendix A: Summary of Assumptions
Appendix B: Grant Summary
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