Assumptions

1. Assume that Google common stock is trading for $200.00 per share paying no divdend on February 7, 2005.

2. Assume that on February 7, 2005, an employee is granted qualified options to purchase 1000 shares at $200.00 per share.

3. Assume that the options have a contractual maximum of10 years to expiration when granted.

4. Assume the options vest 33% per year.

5. Assume that early employee termination will cause the expiration date to change from February 7, 2015 to 90 days after termination.

6. Assume the correct volatility is .34 for an 8 year option.

7. Assume a 4% interest rate for a 6 year government bond on Feb 7, 2005.

8. Assume that the ESOs holder is confident that he will not terminate or be terminated within the next 8 years.

9. Assume that the grant of the options are exempt from SEC Rule 16 b). This may or may not always be the case.

Theoretical Values

The theoretical value of the just granted options to purchase 1000 shares would range from $86,000 - $89,000 (100% time premium).

The theoretical value of the 2 year listed calls would be approximately $4,800 per one hundred shares using a .39 implied volatility (100% time premium).The 2 year LEAPs were selling for $4, 800.00 on February 7, 2005.

Assume that 6 (six) LEAPs were sold (written) and the proceeds were $28,800.00. The seller is liable to be called upon to deliver 600 shares to a holder of 6 LEAPs for $200 per share.

The delta of the six call "time spreads" (i.e. long the 600 ESOs v. short listed LEAPs to purchase 600 shares) are about equal to zero. But the deltas of the extra ESOs to purchase 400 shares are about + 79 each. This makes the total position long deltas of 312 shares with slightly positive "gammas" .

1. Assume that the stock is unchanged 2 years from now.

The 2 year LEAPs would be worthless and the hedger would have made a short term capital gain of $28,800.00 on the 6 LEAPs. However, the ten ESOs will have lost some theoretical value. How much? My estimate is that the 10 ESOs would have decreased by 8 points each or $8,000.00, making the net gain $20,000.00 before taxes. If the hedger had capital loss carry fowards or unliquidated capital losses, he could use the losses to reduce or eliminate the taxes on the gains from the sale of the LEAP calls.

2. Assume on the other hand that the stock advances 50 points after the first two years.

What is the result for the hedged options after two years?

The 2 year LEAPs would be equal to $5000.00 each; causing a loss of 2 points per option written or a total of $1200.00 = ($5000-$4800 x 6).

We would expect the ESOs to have increased about 31 points in theoretical value per ESO or a total of $31,000,00. The net theoretical gain would be about $29,800.00 with no taxes due at this time on the increased value of the ESOs.

3. Assume that the stock decreased to $170 after 2 years when the LEAPs expire.

There would be a gain of $28,800 on the LEAPS sold and a theoretical loss on the ESOs approximately equal to 25 points per ESO or $25,000.00 total on the ESOs There would then be a net theoretical gain of $3,800.00 on the two positions.

Of course, if the stock was substantially lower after the two year period, the gain on the written LEAPs would not have covered all the theoretical loss on the ESOs.

The employee would have the opportunity to write additional listed LEAPs during the life of his ESOs, since he owns ESOs with a potential life of ten years.

Whatever happens, the hedged employee stock options give a safer return and in the majority of cases a greater return.

Prematurely exercising ESOs together with the sale or holding the resulting stock forfeits part of the value of the options and incurs an immediate tax liability. If the options granted were non - qualified ESOs, the gain or loss on the LEAPs would be considered short term capital gain or loss offsetting only a small part of the ordinary gain or loss on the non- qualified ESOs

UPDATE AUGUST 4, 2005

Goggle stock price equals 297 on August 4, 2005.

The 6 LEAPs that we sold on February 7, 2005 have increased from a market traded value of $48 to $118.5.

The ISOs have increased in theoretical value from $88 to $166.5. Even after a 97 point increase, there is still 20 points "time premium' in the 6 LEAP call options, illustrating that the likelyhood of a premature exercise of the LEAPs is still very small.

The ISOs have had an increased theoretical vlaue of $78,500.00

The theoretical Value of the two positions has increased $40,200.00 ( i.e.+ 82,500- $42, 300.00).

We advise closing out the 6 short LEAPs, paying $71,100 and immediately selling 10 Jan 2008 LEAP call, exercise price of 290, for $80,500.00 (i.e. $8,050 x 10).

We are able to report a short term capital loss of $42,300.00 for tax purposes

The theoretical gain on the ISOs is not a gain for current tax purposes and does not offset the $43,300.00 loss for tax purposes.

Since there is no market price to use to recognize the theoretical gain and the employee is prohibited from recognizing the gain , there is no such thing as a "Fair Market Value" for the ISOs.

The position is still bullish.

Our Equity has increased $40, 200.00 and we have a tax deduction. Not too bad so far.

Of course, had he not sold the 6 LEAPs, our theoretical Equity would have increased by $82,500.00. But we understand that if we hedge to reduce risk, we sacrific some potential gain.

Our position can now be described as long a 10x10 time vertical (to use trading floor lingo).

We are long deltas and have positive theta. Our Gammas are about

neuttral.

WARNING. it is possible that these strategies can be accomplished efficiently after a few readings of the articles.

However, to get best results, you will need the help of experts from Truth in Options

FEBRUARY, 20, 2006 UPDATE.

Google is trading at 368.75 (i.e. 71.75 points higher than when we sold the 10 Jan 290 calls of 2008. The sale was at 80.50. The calls are now trading at 135.90 (i.e. 55.40 points higher than the sale at 80.50 in August 2005.

The ISOs have increased in theoretical value from 170.5 to 237( i.e. 66.5 points higher than their value on August 4, 2005.

The implied volatilities have increased and the interest rates have increased thereby adding value to both the listed calls and the theoretical value of the ISOs.

We have seen again a net increase in value (66,500-55,400), with the 71.75 increase in Google stock.

If we were to buy back the 10 listed Leap calls and roll the sale to a different LEAP call, we would be able to report an additional short term capital loss of $55,400 with no taxable gain on the ESOs.

.If nothing were done then the delta and gamma would be about neutral. Essentially, the holder of the position would have little delta potential for gain or loss, although there would be a potential for positive erosion gain.

June 7, 2006 Update

Google stock is trading at 386.51, the Jan 2008 calls with a 290 strike price are selling for $143.30

With the stock 89 dollars higher from the time we sold the Jan 2008, 290 calls, the calls are 63 dollars higher. The price of 143.30 indicates an implied volatility of 42. This indicates an implied volatility for the ISOs of 39. Therefore the theoretical value of the ISOs would be 248.00.

The theoretical value of the ISOs increased more than the market value of the Jan 2008 , 290's since August 5, 2005 because volatilities and interests rates increased additionally. We advise closing the 10 written calls of Jan 2008 with a strike price of 290 and selling 12 Jan 2008 calls with a strike price of 390. (For Officers, Directors and owners of 10% of the stock the appropriate number to sell would be 10) The market value of the 390 calls was 82.5 per call. The closing purchase of the 10 Jan 2008 290 calls resulted in a $63,000 short term capital loss The ISOs have increased $82,000 in theoretical value since August 5, 2005 which is not currently taxable. So we had another net increase with capital tax deductions. Eventually we will have to pay a tax on the ESOs but there is much that can be done over the next 6-8 years to solve that possible issue.

July 29, 2006 Update

Since June 7, 2006 Goggle is up 2 points at 388.50. But the January 2008 390 calls have decreased 5.5 points, giving an unliquidated profit of $6600.

The ESOs would be unchanged in our estimation.

We would not buy in the written calls especially if the hedger is an executive subject to SEC Rule 16 b. If the hedger was not subject to 16 b, considering all factors, he would probably just hold the position. Google reported reasonably good earnings and there is little to make the stock volatile in the short run.

August 14, 2006 update

For non- insiders, who are short 12 Jan, 390 calls v. the 10 ISOs with 200 strike

Buy 4 (four) Jan 2008 410 calls and buy 4 (four) Jan 2008 380 puts. Place the order as a straddle limit of $107.4.This should be easily accomplished. We are advising this partial straddle purchase because there is in our opinion a reasonable chance of an extreme move in either direction which is greater than the market value of the options justifies.

Further updates will be discontinued on this site for Goole. Suggestions can be had by calling John Olagues.

olagues@hotmail.com www.optionsforemployees.com

The author, JOHN OLAGUES, is a former member of the Chicago Board Options Exchange and the Pacific Stock Exchange for over ten years. He offers a unique view of employee stock options from a trader’s standpoint rather than from the standpoint of an accountant, compensation planner or academic. To contact JOHN OLAGUES email olagues@hotmail.com and  see www.optionsforemployees.com.