Heads I Win, Tails I Also Win

We wonder what shareholders of Ampal-American Israel Corp. think about the company’s 2008 performance. 

AMPL performance year-to-date

Not impressed with that chart? Well, the board of trustees at the Israeli acquisition company sure was. Last week, Ampal-American decided to “reprice” its outstanding options for executives “in order to provide adequate incentives to the option holders.” 

That’s a fancy way of saying the company’s stock price has fallen so far, the executives who hold stock options have no realistic hope of ever exercising them, so the company offered to replace them with a new set.  

Chairman and Chief Executive Yosef A. Maiman, for example, had his 250,000 options with a strike price of $3.12 replaced with a new set: 500,000 options priced at $1.17. 

In other words, the board decided that Maiman deserved a special bonus  for presiding over the destruction of 85% of the company’s market capitalization. 

The fun thing about options is that stockholders never seem to understand what’s being taken from them. As Benjamin Graham once wrote , “The stockholders view the issuance of warrants with indifference, failing to realize that part of their equity in the future is being taken from them.” 

Somewhere in an alternate universe, Ampal-American’s board of directors is patiently explaining to stockholders that the company’s executive compensation isn’t excessive because if the stock price had gone down, the executives wouldn’t have gotten anything!

Euro Exchange

We realized we have spent so much time grousing about options, bailouts and other arcane financial matters lately that we have strayed from this blog’s core mission: translating complicated financial and policy questions into plain english. 

So we would like to take a softball question from our sister. Having just moved back to the U.S. after a long stint living and working in Europe, she had most of her savings in euros, which are weakening against the dollar day by day.

The euro's steady decline vs the dollar

She asked Wonk the Plank if we thought she should continue to hold onto her euros or trade them in for dollars. 

Our advice was to keep her savings in the currency of the area she plans on living in for the foreseeable future, the U.S. Since there is no way for her to predict the future behavior of currency exchange rates (the rap star preference for payment in euros notwithstanding), it’s better to remove the uncertainty of future currency fluctuations, which can hurt her just as easily as they can help. 

Come on Jay Z, you know better than to try to time the currency markets

It can be painful to realize this after a substantial decline like Wonk the Plank’s sister just experienced. By way of comfort, we can only offer that the currency markets are extremely efficient, and she probably stood about as good a chance of making a lucky profit on her euros as she stood of suffering a loss. But as with ModernDomestic’s Roth IRA portfolio, that consolation rings a bit hollow.

And Speaking Of Option Goofs…

Take a look at this cringe-inducing embarassment. The AP botched this one badly.  There are student newspapers who wouldn’t run this weak drivel. 

Some Bailout Holdings Down $9 Billion screams the headline. The article insinuates, exposé style, that the value of the government’s bailout holdings has dropped by some $9.3 billion in “barely one month.” 

Unfortunately, the piece was clearly written and edited by a team that had only the vaguest notion of what stock options are and how they work. They made a classic option mistake: confusing the present realizable value of the options with their intrinsic worth. 

“If the government exercised all its warrants to purchase the stock today, it would lose money on 51 of its 53 agreements. Taxpayers would be out $9.3 billion.” The reporters who wrote this, Frank Bass and Christopher S. Rugaber, did not understand that the government doesn’t have to exercise those warrants, not now, and not ever if it isn’t in the government’s best financial interest. That’s why it’s called an option. 

The AP’s analysis would be spot on if the government held the underlying common stock instead of options on that stock. Instead, the government holds preferred shares (which the article does not focus on) and options. Big difference. 

“We’re not exercising the warrants today,” Treasury spokeswoman Brookly McLaughlin said. We can only imagine the look of confusion on her face as she said it. When she read the AP’s finished article, did she wish she belabored the point that even a Sarah Palin Administration would never exercise underwater options? 

Wonk The Plank is especially distressed by this story because it’s so important to have a serious discussion and understanding of the risks the bailout is taking with all of our tax dollars.  The press (and the ’sphere!) have a job to do: unravel all the twists and turns of this thing and put it an honest perspective that ordinary people who don’t spend all their time looking at financial news can understand. Instead, the AP tried for an exciting headline and just muddied the waters. 

 

AP Reporters Bass and Rugaber discuss their next collaboration

Option Goofs

While grinding our teeth at the wretched performance of ModernDomestic’s Roth IRA, we can at least console ourselves that we made suitable investment decisions that just didn’t work out very well.

That isn’t true of the chief executive and chairman of Flir Systems Inc., who recently made a very basic blunder exercising his stock options.

According to Securities and Exchange Commission filings, Earl Lewis exercised 120,000 stock options with a strike price of $18.06 and sold the underlying shares for around $31 each in November. But all the while he held on to other options with an exercise price of $5.87 that expired sooner!

We say that not with the benefit of hindsight. Even at that moment, he should have recognized that keeping options with a lower strike price and a closer expiration date was always a poor choice.

I'll play it safe. I'll take the $100, rather than the $100 plus whatever's in that envelope.

Stock options are a tricky business, so Lewis’ goof might not be immediately obvious to some readers. Let’s try a thought experiment to illustrate his mistake.

Imagine a stock is trading for $101 and you have an option to purchase 1 share for $1, and 100 options with a strike price of $100. The realizable value of either choice is $100. You could either buy a share for $1, and sell it for $101, or you could buy 100 shares for $10,000 and sell them all for $10,100.

Though both choices might have the same realizable value, the 100 options priced at $100 are much more valuable. Why? Because the closer an option trades to its strike price, the more valuable the protection it offers against a decline of the underlying stock. The possibilities for speculative profit vastly outweigh the risks.

On the other hand, the option priced at $1 basically behaves just like a single share of common stock, subject to the same risks and rewards.

Putting an actual dollar value on Lewis’ mistake is beyond our capabilities, but we’d love to hear from anyone who can.