The Wall Street Options Scandal Affects You

by Dual Income No Kids on November 9, 2006 · 0 comments

Today’s posting is about the ongoing options scandal on Wall Street.

Stock options are kind of a mysterious thing, but if you own stock directly or through a fund, you should be keeping an eye on how management is running your company. That said, most folks aren’t options experts (including yours truly), so it makes sense to say a few words of explanation.

As defined by Investopedia an option is: a privilege, sold by one party to another, that gives the buyer the right, but not the obligation, to buy (call) or sell (put) a stock at an agreed-upon price within a certain period. Typically what happens is that companies agree to award their managers with options as a part of their compensation.

Why you should care: If you’re a shareholder, options affects your bottom line. Stock prices are fundamentally driven by earnings per share. When companies grant options, they need to use their profits to pay for the difference between the market and the option price, affecting earnings.

For example, lets say that a company issues their CEO 5,000 options to sell at a price below market value. For example, lets say the market value of the stock is $40, but the option allows the CEO to sell the stock at $35. This means that the company has to make up the difference between the option price and the market price. In this case its, 5 bucks a share. Multiply $5 by 5,000 and you’ve got how much profit your company didn’t make because they chose to compensate the CEO, e.g. $25,000.

The big deal with the backdating scandal is that the options were being fixed so that the CEO’s made more money. Its a problem, especially when it affects the price of your shares.

You might want to take a look at the list of companies and corporate officers that have been implicated in this scandal. Hopefully none of your stocks are involved.

Happy Thursday and Safe Investing!

-James

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