August 12, 2007

Common Sense

WHILE THE BRITISH PAPERS are screaming about the onset of a new wave of economic gloom, I've noticed that American writers are far more sanguine about the present market volatility. Ben Stein, writing in The New York Times, notes the turmoil has come during a time when economic conditions remains strong. For some reason he does not really mention the impact hedge funds have had on the trading that's gone on these past few weeks, but he does make a strong case to individual investors that there really isn't a lot to panic about.

The key quote? "But for now, the sell-off seems extreme, not to say nutty. Some smart, brave people will make a fortune buying in these days, and then we’ll all wonder what the scare was about." Yeah, that sounds about right.

The Times also has a story about company insiders' buying and selling decisions that makes for a good read. Prof H. Nejat Seyhun -- of The University of Michigan -- argues these now indicate a bullishness among executives about their own firms. The Times writes:

For historical comparability, Professor Seyhun argues, insider sales need to be weighed according to whether they occur immediately after the exercise of an option.

In unpublished research, he has done just that. And he has taken into account other factors he has found to be important in interpreting insider behavior. These include the type of insider who made the transaction, the size of the transaction, and whether it occurred in the context of a rising or falling stock price. A good summary of that previous research is in his book, “Investment Intelligence From Insider Trading” (M.I.T. Press).

While I am not familiar with Prof Seyhun's research, it does make sense to discount insider selling, if only for the insiders' tax purposes alone. Since the Government taxes non-qualified (i.e., non-incentive) stock options at the moment one exercises them, it makes sense to immediately sell a portion of the shares one receives simply to cover the tax bill one has acquired as a result. (The rules for ISOs are summarized here). That especially makes sense when one considers what happened to all those poor bastards in Silicon Valley who held on to the entirely of their options, saw the value of their NQSOs evaporate during the collapse of the tech bubble, but found to their horror the Government still wanted its money anyway.

Posted by Benjamin Kepple at August 12, 2007 08:15 AM | TrackBack
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