OPTIONS Lattice Exercise Behavior
Function Description: The OptionsLatticeEB function in FinTools XL is designed to price and evaluate employee stock options (ESOs) using a lattice model. This method is particularly suited to handling the complexities associated with the exercise decisions of ESOs.
Model: Specifies the type of lattice model to use, which may include different formulations to account for various features like early exercise opportunities and changing volatility.
TypeOpt: Indicates whether the option is a call or a put. Employee stock options are typically calls:
- C for Call
- P for Put
Func: Determines the specific output required from the function:
- Price
- Greeks (Delta, Gamma, Vega, Theta, Rho)
- Other sensitivity analyses or implied parameters.
Underlying (S): The current price of the stock or the asset underlying the option. This value is critical as it serves as the starting point for the lattice model's simulation of price paths.
Exercise (X): The strike price of the option, i.e., the price at which the option holder can purchase the stock.
ValueDate: The valuation date of the option, usually today's date or the date on which the option's value is being calculated.
EarlyExerciseDate: The date from which the option holder can start exercising the option. This is particularly relevant for ESOs which often have vesting periods.
ExpiryDate: The expiration date of the option, after which the option cannot be exercised.
Volatility (σ): The expected annualized standard deviation of the stock price returns, a measure of how much the price is expected to fluctuate.
Interest Rate (r): The risk-free interest rate applicable over the life of the option, used for discounting future payoffs.
Yield Rate (q): The dividend yield of the stock, if any, which affects the expected price changes of the stock due to cash distributions.
LatticeType: Specifies the type of lattice (e.g., binomial, trinomial) and the approach for handling the exercise and valuation through the lattice.
SuboptimalEF: A parameter that might be used to adjust for suboptimal early exercise behavior, often modeled to reflect non-rational exercise decisions by employees based on factors other than maximizing financial return.
Exit_PreVest and Exit_PostVest: These parameters define rules or conditions under which employees might exercise their options before and after vesting, respectively, possibly influenced by employment termination or other factors.
These parameters collectively allow the OptionsLatticeEB function to provide a nuanced and flexible tool for pricing ESOs, taking into account the unique characteristics of such options including vesting schedules, early exercise opportunities, and specific employee behaviors.