Sally Jameson

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TEACHING NOTE Sally Jameson: Valuing Stock Options in a Compensation Package (Abridged) Objectives This case has two educational objectives. First, it serves as an introductory case on option valuation in which students can use market data to place a dollar value on an option they are likely to encounter in their business careers. As such, the case encourages a discussion of the application of option pricing models, such as Black-Scholes, and exposes students to popular misconceptions of how options should be valued. Second, the case permits a discussion of the wisdom and efficacy of incentive stock compensation plans using options. Synopsis This case details a thinly disguised situation faced by a recent Harvard MBA graduate…show more content…
The case suggests to students that they first attempt to value the option assuming that Ms. Jameson expects to stay at Telstar for the full five years needed to vest, and ignoring taxes and the lack of tradability of the option grant. The grant gives Ms. Jameson a European call on a non-dividend paying common stock currently selling at $18.75, with an exercise price of $35.00, and a maturity of five years. (In practice, this type of option would be structured so as to vest over the five-year interval, and exercisable over a window from perhaps five to ten years from the date of grant.) The student has to choose between a cash grant of $5000 or 3,000 out-of-the-money calls. Students ' first impressions will likely be similar to those of the executives quoted in the supplementary The Wall Street Journal article: "Out-of-the-money options are worthless.” However, given the volatility of Telstar common stock, their analysis should convince them that these options are far from worthless.1 To value this European call, students need to assess the likely volatility of Telstar common stock, and they have both data that can be used to calculate the historical volatility (Exhibit 3) as well as all of the options quoted on Telstar (Exhibit 1). Instructors can use the case to discuss the mechanics of working through Black-Scholes (e.g., how to back out
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