Q: My company is looking into plan redesign including option repricing to incentivize our executives and other employees in current business conditions; can CVI advise us on stock option grants and alternatives including total-shareholder-return restricted share plans?

A: Companies want maximally motivated employees for their incentive compensation expenditure, and want to understand the expense effects of their compensation structure. CVI gives clients the bottom line impact of any series of alternatives, helps companies compare the alternatives under consideration to current compensation structure, reviews the effects of each component with decision-makers, and provides software to run unlimited variations of the choices available in incentive compensation.

Q: We want to continue to use a Black-Scholes model. Can CVI help us with our expected life and volatility inputs?

A: Regardless of the model your company favors, FAS 123R and IFRS 2 raise the bar on the derivation of your input assumptions. Our analyses employ standardized processes to arrive at input assumptions. Those assumptions, such as an option's expected life, can be used in a Black-Scholes model if that is your preference. Model choice aside, the assumptions are audit-worthy for financial reporting purposes. Most clients can move directly to our lattice-type valuation as soon as they are comfortable doing so.

Q: How can my company arrive at an expected life assumption that our auditor will accept?

A: An analysis of past exercise behavior will yield expected life parameters as an output. Exercise triggers specific to a pool of grantees are applied to a lattice-type framework as part of any robust valuation. A Black-Scholes model requires expected life as an input, which necessitates this analysis. Simplifying assumptions can be appropriate for companies without any grant or exercise history.

Q: How can we calculate a logically-derived volatility assumption that will get through audit?

A: For companies with listed options, an implied volatility term structure incorporates both historical volatility and expectations for the company's future volatility. For private companies and companies without listed options, comparable companies' implied volatilities can be used.

Q: Does CVI take the volatility “smile” into account in its option valuations?

A: Yes. Traded options have an implied volatility "smile" and a "smirk" as well. These are descriptions of the volatility surface, which graphs the dependence of implied volatility on moneyness (and on time to maturity). In the traditional Black Scholes model of unchanging volatility, the volatility surface is constant and there is no need for such descriptions. However, because volatility evolves over time with changes in stock prices, the implied volatility for options traded today isn't constant and depends on moneyness and on time to maturity. The shape of this surface is a "smile" centered at the implied volatility for At-The-Money options, with the edges of the smile the implied volatilities for the furthest Out-Of-The-Money options for which data is available.  

Applying CVI's volatility model to a particular company requires specifically estimating the shape of the volatility surface for that company at each historical time. The resulting parameter estimates provide an accurate estimate of the evolution from short term volatilities to longer term ones. In addition, we also directly estimate the dependence of a company's volatility on its stock price and that is the underlying source of the surface itself.