George Allen's options

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AP reports Sen. George Allen (R-VA) has failed to report stock options given to him byXybernaut and Commonwealth Biotechnologies. Allen's says that he didn't report the options because they were underwater:
Allen's office said he sold his Xybernaut stock at a loss and has not cashed in his Commonwealth options because they cost more than the stock is now worth. The senator also said he saw no conflict going to work for companies shortly after assisting them as governor.

"I actually got no money out of Xybernaut. I got paid in stock options which were worthless. Commonwealth Biotech asked me to be on their board. Glad to do it. I learned a lot on their board and enjoyed working with 'em, and they seem to be doing all right, I guess," Allen said.

...

Allen's office said he did not report his Commonwealth options on his past five Senate disclosure reports because their purchase price was higher than the current market value. Allen viewed them as worthless and believed in "good faith" he did not have to report them, aides said.

Allen disclosed the options once - on an amendment to his 2000 ethics report filed three months after the normal filing period ended. He excluded the options from subsequent reports.

As Radley Balko observes, this is nonsense. As long as Allen is holding an equity position in the company (whether stock or options) then he has a stake in the company's success, and in particular because these companies appear to be partly dependent on Federal contracts. Indeed, Allen appears to have attempted to help Xybernaut while he was still an options holder:

Reid said he is aware of only one time that Allen's office helped any of his former companies. That came in December 2001 when Allen asked the Army to resolve a lingering issue with Xybernaut. The company asked Allen to intervene, and he urged the Army to give Xybernaut an answer, Reid said.

At the time, Allen still owned options to buy 110,000 shares of Xybernaut stock, which could be affected by any new federal contracts.

The Army answered but did not give Xybernaut what it wanted, and Allen did nothing more, Reid said. The office declined to release the correspondence, saying constituent letters are confidential.

More importantly, the claim that options which are underwater are worthless is simply wrong, as a moment's reflection will tell you. If I buy a share of company $X for $10 and then X goes down to $5, I've lost $5. But options are different.

The kind of incentive options issued to employees or directors are effectively calls. They give the option holder the right to buy a stock at some point in the future at a fixed price—no matter what the price of the stock at that future time is. Say that shares of company X are currently trading at $10 and I'm issued an option to buy at $10 (this is called the strike price). If I exercise the option (buy the stock) today, then my profit is $0. But if X shares are ever trading at above $10, then I can exercise the option and sell at the higher price and make money. On the other hand, if the stock price never goes over the strike price, then I don't exercise the option. Because I'm not required to exercise the option, so there's no way I can lose money here, I either make some money or no money.1

Because of this asymmetry, the value of an option isn't determined by whether the stock is currently trading above the strike price but rather by the probability that it will ever trade above the strike price. (There's a complicated model here called Black-Scholes but you don't need to know it to understand this point.) As long as there's some chance that the stock will eventually trade above the strike price than the option has value. That's why employee stock options are valuable even though they're often issued with a strike price equal to the current stock price; the idea is that the stock price will go up.

This really isn't particularly complicated stuff and something one might find it useful to know, particularly if one was serving on the Senate Small Business and Entrepreneurship Committee or the Senate High Tech Task Force.

1. Of course, if you're trading options, then the way you lose money buying calls is that the stock is never worth more than the strike price and you're out the cost of the option, but in this case the options were part of Allen's compensation, so he most likely never paid anything for them.

1 Comments

They should press this more and grind this matter because GA does not follow the same set of rules as we have too.

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