
Options on early stage companies - prakash
http://www.cdixon.org/?p=259
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cwan
Thinking of startup investments as options seems to make a lot of sense but as
one of the commenters there noted: "Black-Scholes is probably a poor model
choice to price start-up options as the return distribution is clearly not
normal."

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voidmain
The choice of model is sketchy but the conclusion is right. Open up excel or
python and do the expected value calculation numerically for any distribution
you like (that's plausible for a very early stage startup) and you will get
pretty much the same price (~1).

For later stage companies, options are poison. If you pay your CEO in options,
his best strategy is to go to Las Vegas and put all of your company's assets
on "black".

~~~
profquail
_For later stage companies, options are poison. If you pay your CEO in
options, his best strategy is to go to Las Vegas and put all of your company's
assets on "black"._

Why is that? Betting on black only has an 18/38 chance of winning (less than
50%), and losing means that his options are going to be out-of-the-money (in
this case, they'd basically be worth nothing).

Not to mention that doing such a thing would probably get him sued by the
shareholders of the company (for not acting in their best interests), whether
he won or not.

~~~
voidmain
Let's say Dr. Evil is chosen as the new CEO of Microsoft, and receives in
compensation ONE BILLION OPTIONS with a strike price of 23.69 (i.e. at the
market) and an expiration in Jan '11. These options are trading on the market
at about $4, so if Dr. Evil sits tight and continues on the company's current
strategy we can assume his compensation will be $4 billion on average. If he
uses the "roulette strategy", on the other hand, his expected return is 23.69
* 18/38 * 1e9 = $11.2 billion. That's much better, and not as much work. In a
company with a lower implied volatility than Microsoft, the options would be
worth less money initially and the roulette strategy would look even better by
comparison.

Now, the shareholder lawsuits could be a problem. So Dr. Evil will have to
look for a way to disguise his strategy. Fortunately (for him), there are lots
of reckless things a company can do that aren't quite as obvious as playing
roulette.

