30 years after the original Black-Scholes work, public understanding of options (and quantitative finance in general) has not improved noticeably. I am speaking about moderately numerate people interested in business and finance, people who can compute bond prices and value stocks with the Gordon model. For some reason we’ve managed to teach them that option pricing requires incomprehensibly complicated mathematics that cannot be explained or trusted.The current event that triggered this thought is the Fortune cover story “The Great CEO Pay Heist.” Apple’s CEO Steve Jobs is on the cover for his $872 million option package. How did Fortune get $872 million? Jobs got at-the-money 10-year call options on 20 million shares at $43.60 per share (quantity and price have been adjusted for a 2 for 1 split). So Fortune multiplied the number of shares by the price per share. When challenged, the magazine said this was the “face value” of the options. Jobs fired off a letter claiming that the options were worth zero, because they had no intrinsic value (however I think he knew that was silly because he didn’t offer to give them away only, only to sell the options to the editors of Fortune for half their face value).I read the Fortune story (a very good story, by the way, especially the anonymous interviews with the board members who approved these pay packages). In the text, the magazine used only $291 million for the value of Jobs options. How did they get this? It’s one-third of the face value which the magazine claims is a common rule of thumb for valuing executive stock options. Fortune also published a table, based on numbers from the AFL/CIO, which valued options by assuming 10 years of stock growth at 10 percent per year and reported the future value ($1,390 million for the Jobs option, considerably more than the value of the underlying stock, although the table did not include Jobs).The Black-Scholes value of Jobs options is reported in Apple’s accounting statements (about $700 million, using 67 percent volatility, 6.2% risk-free rate and no dividend) easily available on-line and off. Moreover, anyone who can price a bond can determine the minimum value of these options as the face value minus the present value of the exercise price ($536 million) since that is what they are worth without optionality, if the holder is forced to exercise. But the AFL/CIO claims values $518 million more than the maximum and Jobs claims a value $536 less than the minimum. This isn’t distrust of the Black-Scholes assumptions, this is willful irrationality. Granted, part of the problem is that this is a political issue and people choose whatever method makes their position look good. But I still find it offensive that a respectable business publication can be so innumerate. There should be some way to communicate basic common sense without advanced mathematics.

In a way I'm not that suprised about what you've told us since within the professional community many traders are still paid a fixed salary and a bonus that is a percentage of their P/L, ie they encourage us to be risk-lovers. This shows that even professionals whose company trade options actively didn't get the message. They look even more irrational to me than the guys you've mentioned.Probably what you'd need is a change in the way finance is taught (I'm not saying anything about the way it is in the US, I just know how it is in Europe). Usually most basic courses start with Net Present Value, and then tell you how a compnay works. Only when you know what a Free Cash Flow or WACC is do they tell you what an option is. And Finally they end up telling you that a stock is a call option on the Invested Assets of the company. When you reach that point, most student who wish to work in investment banking or equity research departments have understood the message: Options are only for the quant people (I'm not a real quant So I have the right to say that) and they are an advanced subject. I think options should be taught just after NPV. You don't need the students to use brownian motion or ito's lemma, as long as they understand basic probability. Then you would see more option valuation arguments in equity research doscuments, and the ideas underlying option theory would spread faster. If you don't believe it is possible, just try to ask the man on the street how much he would be willing to pay to buy an option on an appartment in NYC knowing he can't afford it yet but might be next year, I'm sure most people would get the idea.

I think there are three things we know in finance:(1) When offered a choice, take the larger amount of money.(2) If the amounts are equal, take the earlier money.(3) If the amounts and times are equal, take the more certain money.The mathematical consequences of these principles are elaborate, but most people can grasp the fundamentals. Most financial mistakes spring from ignoring one of these principles rather than computational error.Financial specialists spend most of their education learning mathematics so they can calculate things faster and better. But non-specialists would do better to concentrate on the logic of the field.