This chapter has described the basics of option valuation and discussed option-like corporate securities. In it, we saw that:
Options are contracts giving the right, but not the obligation, to buy and sell underlying assets at a fixed price during a specified time period. The most familiar options are puts and calls involving shares of stock. These options give the holder the right, but not the obligation, to sell (the put option) or buy (the call option) shares of common stock at a given price.
As we discussed, the value of any option depends only on five factors:
The price of the underlying asset
The exercise price
The expiration date
The interest rate on risk-free bonds
The volatility of the underlying asset's value
Companies have begun to use employee stock options (ESO) in rapidly growing numbers. Such options are similar to call options and serve to motivate employees to boost stock prices. ESOs are also an important form of compensation for many workers, particularly at more senior management levels.
Almost all capital budgeting proposals can be viewed as real options. Also, projects and operations contain implicit options, such as the option to expand, the option to abandon, and the option to suspend or contract operations.
A warrant gives the holder the right to buy shares of common stock directly from the company at a fixed exercise price for a given period of time. Typically, warrants are issued in a package with bonds. Afterward, they often can be detached and traded separately.
A convertible bond is a combination of a straight bond and a call option. The holder can give up the bond in exchange for a fixed number of shares of stock. The minimum value of a convertible bond is given by its straight bond value or its conversion value, whichever is greater.
Many other corporate securities have option features. Bonds with call provisions, bonds with put provisions, and bonds backed by a loan guarantee are just a few examples.
