Most of the users on the site have heard of option pricing models (OPM), but most do not know how to use the model. OPMs should be used when you need to value different classes of equity, such as Series A Convertible debt versus Class C common stock. Although each valuation will be different (varying waterfalls, dividends distributed, etc.), I have attached a template model for OPM and will briefly explain how to use it.
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The first thing which will be necessary when using the OPM will to know the value of the underlying company. It makes sense, because in order to derive the value of each class of equity, we need to know the value of ALL the equity. In addition, we will need to find the risk free rate, based on how long you think the Company will be around (for example, a company which will probably liquidate in two years should have an expiration of 2 years, a long-term company, perhaps a 20-year treasury). Pull the corresponding treasury rate for the date of the valuation and input the expiration into the input page.
Dividend yield will always be set to zero for purposes of using the OPM. Set the volatility based on an average of a comparable set of publicly traded companies. On the input section, be sure to input the amount of shares outstanding for all equity classes.
Under the distribution of value section, you will want to allocate the from and to’s based on the rights of each equity class. This section is used to show at what point each asset classes share the proceeds of a possible liquidation. Typically, a preferred class will be allocated value prior to common equity. For example, if a preferred equity class receives all proceeds from the sale of the company up to $10,000,000, and the company sells for $5,000,000, common equity will not receive any proceeds and does not have value at that point. You will want to include any dividends which the preferred classes have rights to between now and a liquidation in the to and froms.
Below this, you will enter the percent each class of equity shares between each break point. So for a sale from $0 to $2,500,000, C convertible debt receives all proceeds, any money sold above that goes straight to B, then A, and if the sale is above $15,000,000, all classes share equally for any proceeds above $15,000,000. You will not need to touch the d1 or d2, and if everything is inputted correctly, it should flow down.
A quick check will be to multiply the per share value times the amount of shares outstanding, and summing these up. The total should equal the original underlying value of the company determined in the beginning.
If anyone has any thoughts, finds any errors, or if I skipped anything, let me know.
| Attachment | Size |
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| OPM WSO.xls 38.5 KB | 38.5 KB |
nice stuff as always GURU
thanks for this
Excellent read
What if the preferred comes with an 8% PIK dividend (or cash for that matter)? What if different parts of the cap structure get different cash/PIK interest - how do you adjust for that?
Honestly, I am not sure. I have not had to deal with that before. I would have to think about it/consult with others.
Thank you, as always guru
Thank you ... how do i have a look at the documents.
MarketXLS works for me just fine for this. It's great
Option pricing questions (Originally Posted: 01/07/2014)
Hi guys,
I have heard that a lot of questions asked in trading interviews involve option pricing, so I would like to know some basic examples for that kind of questions. I have taken introductory option course, so I know sth. about options, but would really want to see how do they look in a real interview?
Nothing too advance from my experience, mostly what happens to different greeks under different scenarios. E.g. what happens to gamma as a call/put gets close to expiration. The goal is more to see if you understand things in depth as opposed to actually pricing something.
Are you looking for brainteaser-like questions or just the generic, "my vanna ran over my lambda" sort? Both types get asked.
@"Martinghoul" : I am looking for both kind of questions, would love to hear brainteaser-like as well :)
In general an interviewer will not have preset questions, but rather start simple and then push the complexity until he finds your breaking point. Therefore questions depend on your knowledge more than anything else.
An example of a generic and basic question is something like this: "What are the key fundamental assumptions of BSM?" The beauty of a question like this is that it opens the floor for some interesting and rich discussions that can go into as much or as little depth as you like.
As to brainteaser-like ones, there's a plethora of 'em (in fact, I think there's even a few books out there, such as this one: http://www.Amazon.com/Heard-Street-Quantitative-Questions-Interviews/dp/0970055285/ref=sr_1_2?s=books&ie=UTF8&qid=1389190469&sr=1-2).
As an aside, how the heck can I insert a friggin' link in a post? Am I being stupid or is this unnecessarily difficult to do here?
Sample Option Pricing Model (Originally Posted: 02/14/2013)
Hey all, does anyone know a good resource for learning how to create different option pricing models or where to find a sample model?
I have read a few books and feel comfortable enough with the theory behind different option pricing methods, but I want to put it to practice with a "real" model. Thanks in advance.
If you're comfortable with the theory behind options pricing, putting it into practice is child's play in comparison. Which models are you interested in building out?
You should be able to find something online to use as a base and then expand from there. Ex. below http://pages.stern.nyu.edu/~adamodar/
Aren't all the "good" models in a black box environment ?
Best book on pricing models is models On models by haag
Another really good one is Natenberg's Option Volatility & Pricing.
Not a book on pricing models at all, just a general overview of options trading
MarketXLS works for me well.. They have regular updates and customer support,
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