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Understanding Options Compensation


siddharth18
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Hey all,

 

I was perusing Mike Burry's early letters where here discussed options compensation in riveting detail. My understanding of options pricing and the respective accounting is quite superficial at this point. His contention is that the traditional way options are priced, expensed and accounted for - is based on Black-Scholes and hence meaningless. Also that intrinsic value is created if the company issues shares at price above intrinsic value.

 

I would like to know if anyone else calculates the option compensation in a way Dr. Burry does? Does any book/article cover this subject in detail? Has Buffett touched this topic?

 

Here is the link to letter: http://www.scioncapital.com/PDFs/Scion%202001%202Q_web.pdf (starting page 3)

 

To quote Burry: "The investors in the habit of overturning the most stones will find the most success."

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Principles for the Application of Fair Value Accounting

http://www4.gsb.columbia.edu/null?&exclusive=filemgr.download&file_id=3822

 

Timely & True from an Owner’s View: Shareholder Value Accounting for Employee Stock Options

http://www8.gsb.columbia.edu/sites/ceasa/themes/ceasa/css/files/PolicyBrief_1.pdf

 

Timely & True from an Owner’s View: Shareholder Value Accounting for Employee Stock Options

http://www.bus.iastate.edu/aclem/592/SS03/Penman.pdf

 

Do Firms Understate Stock Option-Based Compensation Expense Disclosed under SFAS 123?

http://www.anderson.ucla.edu/faculty/david.aboody/ABK_RAST_Forthcoming.pdf

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Wasn't Burry referring to the time when options weren't expensed at all?

If option compensation is high and you think the stock is undervalued you should make some adjustments to what's expensed since that calculation assumes that the current stock price is a fair value. Giving someone an option on a $100 dollar stock that has an IV of $100 is not the same as giving someone an option on a $100 dollar stock with an IV of $200 (assuming everything else is the same). The accounting expense would be equal in both scenario's.

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