Joseph has been offered a job at MHP in July 2013. The compensation will include 20,000 stock options that will vest in 4 years. The contract stipulates that Joseph can buy, at the end of 4 years (i.e. July 2017), up to 20,000 shares of MHP at the current price of $30 per share. As a policy, MHP does not distribute dividends to its shareholders and instead retains the earnings for future use. This ensures that all the growth in the company is translated into its market capitalization. The current money market accounts/treasury bonds provide a risk free return of 5% per year.

Joseph sits down and estimates the market and cash flows for Morton’s products. He guesstimates that each year the stock price of MHP would either go up by 30% or go down by 10% over and above the risk-free return.

Question: 

What is the Relation between stock option valuation and the probability of stock going up/down?

Answer rating: 100% (QA)

The valuation of stock options is influenced by various factors including the probability of the sto... View the full answer