A recent issue of the Wire included the article, “Reduced liquidity may lead to larger marketability discounts in the current economy,” featuring a comment made by Lance Hall, ASA ,of FMV Opinions in New York City at the 2008 Summit on Discounts for Lack of Marketability. Hall maintained that, “During periods of increased volatility, investors desire an increased ability to sell, so it makes sense that cash flows might decrease in an analysis, and discounts might also increase.”
In a Letter to the Editor, Ronald M. Seaman, FASA, of Tampa, Florida’s Southland Business Group, responded that it would not be difficult to prove such a statement by studying the current costs of publicly traded LEAPS put options compared to costs in some earlier period. To find out, Seaman—while in the process of preparing an exhaustive study of 2008 discounts for lack of marketability based on LEAPS—decided to address the issue (see the table below).
His conclusion: Lance Hall is exactly right. In fact, Seaman’s research found that “discounts for lack of marketability in late November 2008 are more than double those in August 2006, and, in virtually every case, the underlying stock prices per-share are much lower as well.”
According to Seaman, “The 283 companies are all of the companies whose names begin with the letters A through F and who had LEAPS put options available for purchase on both study dates. As in my prior studies, the discount is calculated as the cost of the put option divided by the price of the stock.” He adds, “In the November 2008 study, company counts are significant for two reasons. First, despite the major increases in option costs (which resulted in higher discounts) and a three-month shorter option period, market makers in 2008 did not offer a two-year option (2011 option) for 103 companies that they sold options for in 2006 (the 2009 option); clearly this is a reflection of long-term risk in the market. Secondly, the difference between 283 companies in 2006 and 259 companies in 2008 (24 companies) is due almost exclusively to the fact that in 2008 the stock of these companies sold for well below the minimum option price of $2.50 per share, so no meaningful discount could be calculated.
“It is also an interesting result of perceived market risk in 2008 that the absolute percentage spread (i.e., the cost of the option) between the one-year (the 14-month or 17-month option) and the two-year option (the 26-month or 29-month option) has increased from the 3% to 4% range in 2006 to the 7% to 8% range in 2008,” Seaman says.
Seaman is currently conducting another study of the entire LEAPS market that will focus on industry differences. The results will not be ready for a few months; however, you can read the entire 2006 study online.