December 2006 Archives

Adam Warner, the author of daily options report, provided a quick snapshot of the different Greeks. As I have said in the past, if you are at all interested in investing, you definitely need to Adam's blog. Options are already a significant part of the investment landscape and are only becoming bigger. Even if you have no intent to trade options today, you should at least have a rudimentary understanding as to how options work and the interplay between stocks and options.

Adam's discussion of the Greeks is as follows:

1. Know Your Greeks is a discussion about vega or volatility.
2. Know Your Greeks Part Deux is a discussion about delta or how much an option price moves relative to the change stock price.
3. Know Your Greeks Part Tres is a discussion about gamma or how much delta moves relative to the change in stock price.
4. Know Your Greeks, The End is a discussion about theta or the change in options price per day, everything else being kept equal.

Adam provided easy to understand discussions on all of the topics. His discussions are meant as an introduction. So if you are new to options (also known as derivatives), these series of articles are a helpful primer.

This article is a follow up to two earlier articles on Apple's option woes here and here.

Apple Computer, Inc.'s (AAPL) said the following in its 10-Q filed on 29 December 2006:

The independent counsel and its forensic accountants (“Investigative Team”) reviewed the facts and circumstances surrounding stock option grants made on 259 dates. The Investigative Team spent over 26,500 person-hours searching more than one million physical and electronic documents and interviewing more than 40 current and former directors, officers, employees, and advisors. Based on a review of the totality of evidence and the applicable law, the Special Committee found no misconduct by current management. The Special Committee’s investigation identified a number of grants for which grant dates were intentionally selected in order to obtain favorable exercise prices. The terms of these and certain other grants, as discussed below, were finalized after the originally assigned grant dates. The Special Committee concluded that the procedures for granting, accounting for, and reporting stock option grants did not include sufficient safeguards to prevent manipulation. Although the investigation found that CEO Steve Jobs was aware or recommended the selection of some favorable grant dates, he did not receive or financially benefit from these grants or appreciate the accounting implications. The Special Committee also found that the investigation had raised serious concerns regarding the actions of two former officers in connection with the accounting, recording and reporting of stock option grants.

Let me see if I understand the situation. We learn that there has been no misconduct by current management. In the next sentence, we learn that "...identified a number of grants for which grant dates were intentionally selected in order to obtain favorable exercise prices." Now if we were to learn that management had a role in selecting those special dates, that would be misconduct, no? I mean, that is what all the fuss is about. Let us read on. "...CEO Steve Jobs was aware or recommended the selection of some favorable grant dates..." That cannot be good. "...he [Steve Jobs] did not receive or financially benefit from these grants or appreciate the accounting implications." Oh well, I guess that makes it okay. Steve Jobs had a role in selecting some favorable grant dates, though he did not financially benefit. Well, who did benefit? Did the shareholders benefit? Let us not forget is that it is stockholders who actually own the company, and Steve Jobs, is still just an important employee.

Imagine a kid working at a local gas station letting all his friends go through the car wash without paying. Finally, one day the owner of gas station catches on and grabs the kid by the lapels. The kid replies, "Honest sir, although I have let all my friends through your car wash, I did not personally benefit. And it did not cost you much, just some water, soap, power, and a bit of wear and tear on your equipment." If you were the owner of the gas station, how sympathetic would you be? Me, if I were in a good mood, I would simply fire him.

Steve Jobs is a mercurial genius who undoubtedly saved Apple and created billions in shareholder value for its shareholders. Steve Jobs is no bozo. He ought to have known that adjusting option granting dates is not a good thing to do.

Because Jobs has been so instrumental in the company's success, I am sure that the company and its directors will do everything possible to protect him. I am guessing that he will remain in his current roles. Apple shareholders will be better served if he remains in place. All that said, I do not think we should simply excuse his behavior because he did not personally benefit monetarily.

The photograph of Paula Anddrade is hosted at Flickr. If you click on her picture above, you will be taken to a larger version at her photostream on Flickr, where she has many other beautiful pictures. I like her treatment of this picture where she took a photo and made it seem like a high art drawing. Well done Paula.

Yesterday I wrote an article that discussed the options problem beginning to brew at Apple Computer, Inc. (AAPL). Today, The Financial Times has an article Apple ‘falsified’ files on Jobs’ options (subscription required) that might prove harmful. The Financial Times article is worthwhile reading.

Steve Jobs, chief executive of Apple Computer, was handed 7.5m stock options in 2001 without the required authorisation from the company’s board of directors, according to people familiar with the matter.

Records that purported to show a full board meeting had taken place to approve Mr Jobs’ remuneration, as required by Apple’s procedures, were later falsified. These are now among the pieces of evidence being weighed by the Securities and Exchange Commission as it decides whether to pursue a case against the company or any individuals over the affair, according to these people.

I am uncomfortable with people familiar the matter. Just who are these people that are familiar with the matter? What happens if they are wrong? If some people know, why cannot the regulatory bodies inform all of us so that we no longer need to rely upon those people familiar with the matter? At least if the information was released from a regulatory body, all investors would be privy to material information at the same time. So now we have hearsay to rely upon. Maybe it is right, maybe it is wrong. But it definitely affected Apple's stock. At present, the stock is down 2.05% or a $1.67 to $79.85.

I have no positions in Apple Computer.

Doug Kass, general partner of Seabreeze Partners Management, Inc. and commentator for The Edge Column on Street Insight (subscription required—part of TheStreet.com family), highlighted an excellent article on CNNMoney.com titled Apple reportedly falsified options documents that further speaks to the options scandals (see my earlier post today Executive Compensation & Options). Because of this further mess with options, Apple Computer, Inc. (AAPL) is down about 4.3% to $77.96. I do not have any thoughts on Apple, but it will be an interesting story to watch.

The Wall Street Journal has a very good general article titled Open Spigot Bosses' Pay: How Stock Options Became Part of the Problem (subscription required) on options used as executive compensation. This past year, option backdating scandals have surfaced an unimaginable abuses. This general article serves as a good primer to help better understand option backdating. But more than simply understanding backdating, the article outlines, in general terms, how options can be abused.

While I favor the use of options to create an incentive for executives to do well, I do not believe executives should reap outrageous rewards. As good as executives are, there are always other capable candidates who would do a very good job if given the chance. And if the company is well managed, it should have a lot of bench strength so that the CEO is not indispensable.

I recommend reading the WSJ article, especially if you are not well versed in options and have not been following the backdating scandals.