P&G's Record Prices - What To Do With Your Stock Options - Part 1 of 4
P&G STOCK OPTIONS: GAME OF CHANCE OR MATHEMATICAL EXERCISE?
This great song from the late Kenny Rogers reminds us that we can view P&G stock options in one of two ways—as somewhat of a game of chance (where we roll the dice and hope for the best) or as a mathematical exercise designed to produce the greatest risk/reward relationship. While it’s easier to close our eyes and hope for the best, at Clarity Wealth Management we believe that a mathematical, risk-managed approach makes more sense and offers more upside over time than the easier, less analytical approach to a stock option strategy.
Having dealt with P&G stock options for almost three decades, the number one question we get from nearly every P&G corporate executive is when to exercise their stock options. Obviously, if we knew the exact best time to do so for every grant, we would be on our way to Las Vegas to try our expertise at even more lucrative endeavors.
But, given that every grant has a different strike price and that the volatility of P&G stock (not to mention the stock market itself!) goes up and own over time, we were determined long ago to come up with a better way of guiding our clients with regards to knowing when to “hold 'em” and knowing when to “fold ‘em” when it comes to P&G stock options.
WHEN TO EXERCISE P&G STOCK OPTIONS…
With access to a firm that specializes in stock options analysis and risk management, we have come up with a process called "The Stock Options Analyzer” ™. This analysis takes the guesswork out of the basic “when to exercise” question and replaces it with a disciplined exercise strategy that is based upon prudent risk management calculations. As part of our “Clear Path Process”™ that we take our P&G executive clients through, we are able to put together a proactive game plan for when to exercise each of their stock option grants in order to optimize the after-tax value of each grant while minimizing the potential loss given the volatility of the overall market and P&G stock.
In the next few blog posts, we will focus on some features of "The Stock Options Analyzer”™ and how it can help P&G executives who hold stock options to better understand the potential rewards of each grant and the potential pitfalls of not having a disciplined strategy in place when it comes to deciding how and when to exercise their stock option grants. Whether you use our methodology or not for your own stock option grants, you will be better informed and able to make wiser choices.
WHAT IS THE “TODAY’S VALUE” OF A P&G STOCK OPTION GRANT?
So, let’s focus first on “Today’s Value”-- what we would realize by exercising an option today and before the impact of income taxes – using as an example the February 2012 grant below. Even though many other stocks and stock options have taken a hit with this year’s uncertainties in the markets, this P&G grant has some tremendous potential value given the low strike price of $67.52 and the fact that we have less than two years until expiration.
Just for hypothetical illustrative purposes, let’s use a PG stock price of $141/share and assume a grant of 13,000 shares. If we look at the metrics, we see:
ITMW is the "in the money market value" or what we call "Today's Value."
So, in our example, how do you know when to “hold ‘em” and how do you know when to “fold ‘em”?
To answer that question, we need to understand the concept of leverage that comes with owning stock options. In very basic terms, “leverage” in our example means that the dollar value of your stock options will change in a more dramatic way than the actual percentage change in the stock price. Here’s an example…
Current Value is the "in the money market value" or what we call "Today's Value."
If P&G’s stock price falls back to $112.80/share (which was a pretty good price just last year!), that’s “only” a 20% drop from $141. However, the change in the actual dollar value of the grant was almost 40%! A loss of over $365,000 on a pre-tax basis.
Obviously, in this comparison, that $141/share price looks great. That $112.80/share price looks pretty bad. But, since (in our example) we haven’t yet exercised the options, is it worth trying to wait for $150/share? That’s the exact question "The Stock Options Analyzer”™ is designed to answer. Without a mathematically and goals-based plan, you could be leaving it up to chance. Next time, we’ll think through the pros and cons of continuing to hold the 2012 stock option grant in our example and look at a more effective way of addressing this question.
As always, if you would like to discuss your stock options, have any questions or if we can help in any way, please feel free to contact us at ClarityWealth@LFG.com or 513-745-7095.
Jay A. Finke, CFP®, Matt A. Held, CFP® and Robert V. Molenda, CLU, ChFC, CRPC®
The above example is for illustration purposes only and you should not base any decisions solely on it. Nothing contained in this example should be construed as investment recommendations or advice. The financial calculations provided herein are to help you understand the value, risk, and potential of an equity compensation portfolio. The values and risks illustrated in this example in no way represent a guarantee that the portfolio will produce a particular result. Additionally, past performance of your company stock is no guarantee of future results.
The Full Option Values (FOV) and the Time Values were calculated using the Black-Scholes Merton model with an estimated volatility of 25.00 % for PG to illustrate option value. Any estimate of the future volatility of a stock price is uncertain. Therefore, there is no guarantee that the volatility used accurately illustrates the Time Value of your employee stock options. In addition, the Black-Scholes Merton model was originally designed to value market traded options. Consequently, there are some inherent limitations to the Black-Scholes Merton methodology for valuing employee stock options. Because of these limitations, this model may overstate or understate the actual value of employee stock options. However, since there isn’t a generally recognized methodology for adjusting its results for such issues, the estimated Full Option Value (FOV) and Time Value (TV) amounts contained in this report are the full, unadjusted Black-Scholes Merton model values.
Jay Finke and Matt Held are registered representatives of Lincoln Financial Advisors Corp. Securities and investment advisory services offered through Lincoln Financial Advisors Corp., a broker/dealer (member SIPC) and registered investment advisor. Insurance offered through Lincoln affiliates and other fine companies. Lincoln Financial Advisors Corp. and its representatives do not provide legal or tax advice. You may want to consult a legal or tax advisor regarding any legal or tax information as it relates to your personal circumstances. Clarity Wealth Management Is a marketing name for registered representatives of Lincoln Financial Advisors Corp.