Understanding Scenarios Analysis
Learn how different equity compensation types respond to stock price movements and understand the difference between linear and leveraged instruments.
What is Scenarios Analysis?
Scenarios provides a visual analysis demonstrating how different equity compensation types respond to stock price movements, ranging from -80% to +80%. This analysis reveals the fundamental differences between linear equity instruments and leveraged equity instruments, enabling clients and advisors to understand risk exposure and potential outcomes across various market conditions.
Linear vs. Leveraged Instruments
Linear Instruments
Linear instruments include:
- Stock owned outright
- RSUs (Restricted Stock Units)
- ESPP shares (Employee Stock Purchase Plan)
Characteristics:
- Exhibit 1:1 correlation with stock price movements
- Delta of 1.000, meaning every 1% change in stock price produces exactly 1% change in position value
- No time decay
- No volatility impact on valuation
Leveraged Instruments
Leveraged instruments include:
- ISOs (Incentive Stock Options)
- NSOs (Non-Qualified Stock Options)
Characteristics:
- Variable leverage that changes based on multiple factors
- Variable delta ranging from near 0 when deep out-of-the-money to 1.0 when deep in-the-money
- Time decay that accelerates as expiration approaches
- Volatility sensitivity that increases or decreases their value
Understanding Options Leverage
Options create leverage through their strike price mechanism, with leverage typically ranging from 1.1x to 1.25x or higher. A 10% stock price movement might produce a 12% or 15% change in option value, magnifying both upside potential and downside risk.
When Leverage is Maximum
Maximum leverage occurs when options are at-the-money or slightly out-of-the-money.
When Leverage Diminishes
As options move deeper in-the-money, the leverage effect diminishes—the leverage converges down toward 1.0x and the option behaves more like owning stock. The deeper in-the-money an option goes, the more the leverage juice has been squeezed out, with the option eventually moving nearly in lockstep with the underlying stock.
How the Visualization Works
The scenarios tab displays a line diagram showing each equity compensation type's value across the stock price range.
Horizontal Axis
Shows percentage stock price movement from -80% to +80%
Vertical Axis
Shows current dollar value of each position
Position Lines
Each equity compensation position displays on its own line representing that specific position's current dollar value and how it responds to stock price movements. A $500,000 option position displays separately from a $50,000 RSU position, with each showing its respective value changes across the price movement range.
Dollar Impact Differences
While percentage movements remain constant for linear instruments, absolute dollar changes differ based on the starting stock price. A 20% move on an $80 stock produces different absolute dollar impact than a 20% move on a $100 stock, illustrated by different dollar values on the vertical axis.
Market Assumption Integration
The scenarios diagram connects to market assumptions established earlier:
Current Stock Price Serves as the baseline where all scenario lines are measured
Growth Rate Assumptions Help identify the most probable region of outcomes within the full range shown
Volatility Assumptions Affect the shape and value of options curves, with higher volatility increasing option values across price points