May 1, 2004
LOG OUT
Post ESO ED: Comp Plans for Growth  
April 5, 2004
Still No End to Black-Scholes for ESOs
February 11, 2004
Planned Effective Date: IFRS Share Based Payment  
January 1, 2004
Road Testing Equity-Based Comp Fair Valuations
October 31, 2003
'Haircuts' on Restricted Stock a Debate for Later
October 3, 2003
Derivatives Accounting (FAS 133/IAS 39)
Closing the (price) Gap
April 7, 2003

The gap between the theoretical (mark-to-model) and the real market value of FX options has always been a thorn in the side of the fast-growing derivatives market. That gap is particularly wide when it comes to exotic structures (and employee stock options, see below).

Both banks and corporate hedgers have been concerned about the pricing of FX options, often for different reasons. Banks want to make sure they can lay off their risk cost effectively. Corporates, meanwhile, want to make sure banks do not overcharge.

A confluence of trends

Several recent trends have brought this gap (between what models say the option should be worth and the price that the market is actually willing to pay for it) into sharper focus.

• Regulatory issues. FAS 133 and IAS 39 have made the fair value of an option of significant concern to corporates; that’s because the derivatives’ accounting rules mandate that companies carry options and other derivatives at fair value on their balance sheet. Just what’s fair, hence, has suddenly become very important not only when purchasing/trading an option, but on an ongoing basis.

Corporate hedgers need to price their option hedges quarterly, and that quarterly “price” is critical to the measurement of the hedges’ effectiveness, and hence what gets recognized in the income statement and where.

In the past, banks have often supplied their corporate customers with pricing for “free.” But in the post FAS-133 era, simply relying on the bank became less workable because of (1) the frequency of the measurement; and (2) the need for objectivity in the value assessment.

• Market dynamics. Meanwhile, past large derivatives debacles (e.g., P&G) have convinced corporate hedgers of a basic axiom: “If you cannot price it, don’t use it.” This, plus pressure to cut costs have pressured many to seek alternative (and objective, i.e., not provided by the bank that’s selling the structure) pricing models.

A real vs. M-T-M price

Against this backdrop, independent providers of analytics have stepped in to help corporate treasurers price their derivatives. Unfortunately, some (with a banking background) have failed to adjust to corporate realities, costs and issues. One company, however, which did originally cater to banks, is making an interesting transition.

SuperDerivatives is a website-resident pricing model, which made its mark by being able to produce the real market price of exotic options, vs., the typical Black Scholes-based pricing. The company began its life selling the model to banks, as either a primary or secondary model. More recently, it has simplified its user interface so that it’s just as easy and quick to price plain-vanilla options and turned its attention to corporates.

“The intention was always to sell SuperDerivatives to the whole of the options spectrum,” notes Lee Oliver, a company spokesman.

According to one corporate FX manager who’s company will soon start pricing options on the site (http://www.superderivatives.com/), the goal is to check on bank pricing, without having to competitively bid every deal. This will not only save time and money, but is also better from a bank credit relationship standpoint.

What about ESOs? No where is the gap between “real” and mark-to-model price wider than in the pricing of employee stock options (see TRAS, 3/24/03). David Gershon, CEO of SuperDerivatives, says he is ready to apply the solution to ESOs, ideally offering the same transparency to that market as he has done with FX.

 


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