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Sample Business Contracts

1996 Executive and Non-Employee Director Stock Option Plan - NovaStar Financial Inc.

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                            NOVASTAR FINANCIAL, INC.

                              AMENDED AND RESTATED

                    1996 EXECUTIVE AND NON-EMPLOYEE DIRECTOR

                               STOCK OPTION PLAN

                        (Last Amended December 6, 1996)

1.  GENERAL PURPOSE OF PLAN; DEFINITIONS.

          The name of this plan is the NovaStar Financial, Inc. 1996 Executive
and Non-Employee Director Stock Option Plan (the "Plan").  The Plan was adopted
by the Board on September 27, 1996, subject to the approval of the Company
stockholders, which approval was obtained on October 10, 1996.  The purpose of
the Plan is to enable the Company and its Subsidiaries to obtain and retain
competent personnel who will contribute to the Company's success by their
ability, ingenuity and industry, to give the Company's non-employee directors a
proprietary interest in the Company and to provide incentives to the
participating directors, officers and other key employees, and agents and
consultants that are linked directly to increases in stockholder value and will
therefore inure to the benefit of all stockholders of the Company.

          For purposes of the Plan, the following terms shall be defined as set
forth below:

          (1) "Accrued DERs" means dividend equivalent rights with the accrual
               ------------                                                   
rights described in Section 5(11).

          (2) "Administrator" means the Board, or if the Board does not
               -------------                                           
administer the Plan, the Committee in accordance with Section 2.

          (3) "Board" means the Board of Directors of the Company.
               -----                                              

          (4) "Code" means the Internal Revenue Code of 1986, as amended from
               ----                                                          
time to time, or any successor thereto.

          (5) "Committee" means the Compensation Committee of the Board, which
               ---------                                                      
shall be composed entirely of individuals who meet the qualifications to be a
"Non-Employee Director" as defined in Rule 16b-3 ("Rule 16b-3") as promulgated
by the Securities and Exchange Commission (the "Commission") under the
Securities Exchange Act of 1934 (the "Act"), and as such Rule may be amended
from time to time, or any successor definition adopted by the Commission, or any
other Committee the Board may subsequently appoint to administer the Plan. If at
any time the Board shall not administer the Plan, then the functions of the
Board specified in the Plan shall be exercised by the Committee.

                                       1
<PAGE>
 
          (6) "Company" means NovaStar Financial, Inc., a corporation organized
               -------                                                         
under the laws of the State of Maryland (or any successor corporation).

          (7) "Current-pay DERs" means dividend equivalent rights with the
               ----------------                                           
current-pay rights described in Section 5(11).

          (8) "DERs" shall mean Accrued DERs and Current-pay DERs.
               ----                                               

          (9) "Deferred Stock" means an award granted pursuant to Section 7 of
               --------------                                                 
the right to receive Stock at the end of a specified deferral period.

          (10) "Disability" means permanent and total disability as determined
                ----------                                                    
under the Company's disability program or policy.

          (11) "Effective Date" shall mean the date provided pursuant to Section
                --------------                                                  
12.

          (12) "Eligible Employee" means an employee of the Company or any
                -----------------                                         
Subsidiary eligible to participate in the Plan pursuant to Section 4.

          (13) "Eligible Non-Employee Director" means a member of the Board or
                ------------------------------                                
the board of directors of any Subsidiary who is not a bona fide employee of the
Company or any Subsidiary and who is eligible to participate in the Plan
pursuant to Section 5A.

          (14) "Fair Market Value" means, as of any given date, with respect to
                -----------------                                              
any awards granted hereunder, at the discretion of the Administrator and subject
to such limitations as the Administrator may impose, (A) the closing sale price
of the Stock on the next preceding business day as reported in the Western
Edition of the Wall Street Journal Composite Tape, or (B) the average of the
closing price of the Stock on each day on which the Stock was traded over a
period of up to twenty trading days immediately prior to such date, or (C) if
the Stock is not publicly traded, the fair market value of the Stock as
otherwise determined by the Administrator in the good faith exercise of its
discretion.

          (15) "Incentive Stock Option" means any Stock Option intended to be
                ----------------------                                       
designated as an "incentive stock option" within the meaning of Section 422 of
the Code.

          (16) "Limited Stock Appreciation Right" means a Stock Appreciation
                --------------------------------                            
Right that can be exercised only in the event of a "Change of Control" (as
defined in Section 10 below).

          (17) "Non-Employee Director" shall have the meaning set forth in Rule
                ---------------------                                          
16b-3.

          (18) "Non-Qualified Stock Option" means any Stock Option that is not
                --------------------------                                    
an Incentive Stock Option, including any Stock Option that provides (as of the
time such option is granted) that it will not be treated as an Incentive Stock
Option.

                                       2
<PAGE>
 
          (19) "Parent Corporation" means any corporation (other than the
                ------------------                                       
Company) in an unbroken chain of corporations ending with the Company, if each
of the corporations in the chain (other than the Company) owns stock possessing
50% or more of the combined voting power of all classes of stock in one of the
other corporations in the chain.

          (20) "Participant" means any Eligible Employee or any consultant or
                -----------                                                  
agent of the Company or any Subsidiary selected by the Committee, pursuant to
the Administrator's authority in Section 2, to receive grants of Stock Options,
DERs, Stock Appreciation Rights, Limited Stock Appreciation Rights, Restricted
Stock awards, Deferred Stock awards, Performance Shares or any combination of
the foregoing, or any Eligible Non-Employee Director eligible to receive grants
of Non-Qualified Stock Options and DERs pursuant to Section 5A below.

          (21) "Performance Share" means an award of shares of Stock granted
                -----------------                                           
pursuant to Section 7 that is subject to restrictions based upon the attainment
of specified performance objectives.

          (22) "Restricted Stock" means an award granted pursuant to Section 7
                ----------------                                              
of shares of Stock subject to restrictions that will lapse with the passage of
time.

          (23) "Stock" means the common stock, $0.01 par value, of the Company.
                -----                                                          

          (24) "Stock Appreciation Right" means the right pursuant to an award
                ------------------------                                      
granted under Section 6 to receive an amount equal to the difference between (A)
the Fair Market Value, as of the date such Stock Appreciation Right or portion
thereof is surrendered, of the shares of Stock covered by such right or such
portion thereof, and (B) the aggregate exercise price of such right or such
portion thereof.

          (25) "Stock Option" means an option to purchase shares of Stock
                ------------                                             
granted pursuant to Section 5 or Section 5A.

          (26) "Subsidiary" means any corporation (other than the Company)
                ----------                                                
either (i) in an unbroken chain of corporations beginning with the Company, if
each of the corporations (other than the last corporation) in the unbroken chain
owns stock possessing 50% or more of the total combined voting power of all
classes of stock in one of the other corporations in the chain or (ii) organized
to act as the mortgage loan conduit for the Company.

2.  ADMINISTRATION.

          The Plan shall be administered by the Board or by a Committee
appointed by the Board, which shall serve at the pleasure of the Board;
provided, however, that at all times following the commencement of the Company's
--------  -------                                                               
Private Placement on October 15, 1996 the Plan shall be administered by the
Committee appointed by the Board.

                                       3
<PAGE>
 
          The Administrator shall have the power and authority to grant to
Eligible Employees and consultants or agents of the Company or any Subsidiary,
pursuant to the terms of the Plan: (a) Stock Options (with or without DERs), (b)
Stock Appreciation Rights or Limited Stock Appreciation Rights, (c) Restricted
Stock, (d) Deferred Stock, (e) Performance Shares or (f) any combination of the
foregoing.

          In particular, the Administrator shall have the authority:

          (a) to select those employees of the Company or any Subsidiary who
shall be Eligible Employees;

          (b) to determine whether and to what extent Stock Options (with or
without DERs), Stock Appreciation Rights, Limited Stock Appreciation Rights,
Restricted Stock, Deferred Stock, Performance Shares or a combination of the
foregoing, are to be granted to Eligible Employees or any consultant or agent of
the Company or any Subsidiary hereunder;

          (c) to determine the number of shares to be covered by each such award
granted hereunder;

          (d) to determine the terms and conditions, not inconsistent with the
terms of the Plan, of any award granted hereunder (including, but not limited
to, (x) the restricted period applicable to Restricted or Deferred Stock awards
and the date or dates on which restrictions applicable to such Restricted or
Deferred Stock shall lapse during such period, and (y) the performance goals and
periods applicable to the award of Performance Shares); and

          (e) to determine the terms and conditions, not inconsistent with the
terms of the Plan, which shall govern all written instruments evidencing the
Stock Options, DERs, Stock Appreciation Rights, Limited Stock Appreciation
Rights, Restricted Stock, Deferred Stock, Performance Shares or any combination
of the foregoing.

          The Administrator shall have the authority, in its discretion, to
adopt, alter and repeal such administrative rules, guidelines and practices
governing the Plan as it shall from time to time deem advisable; to interpret
the terms and provisions of the Plan and any award issued under the Plan (and
any agreements relating thereto); and to otherwise supervise the administration
of the Plan.

          All decisions made by the Administrator pursuant to the provisions of
the Plan shall be final and binding on all persons, including the Company, any
Subsidiaries and the Participants.

3.  STOCK SUBJECT TO PLAN.

          The total number of shares of Stock reserved and available for
issuance under the Plan shall be 339,332; provided, however, that from and after
                                          --------  -------                     
such time as the number of outstanding shares of Stock as reflected on the
Company's quarterly or year-end balance sheet exceeds 

                                       4
<PAGE>
 
3,393,320 (including treasury shares but not including adjustments in the event
of changes in the corporate structure of the Company as provided below in this
Section 3), the total number of shares of Stock reserved and available for
issuance (inclusive of shares already issued) under the Plan shall automatically
be increased so as to equal ten percent (10%) of the number of then outstanding
shares of Stock, and provided further, that no more than 339,332 shares of Stock
                     ---------------- 
shall be cumulatively available for Incentive Stock Options. At all times, the
number of shares reserved and available for issuance hereunder as so determined
from time to time shall be decreased by virtue of awards granted and outstanding
or exercised hereunder.

          To the extent that (i) a Stock Option or DER expires or is otherwise
terminated without being exercised, or (ii) any shares of Stock subject to any
Restricted Stock, Deferred Stock or Performance Share award granted hereunder
are forfeited, such shares shall again be available for issuance in connection
with future awards under the Plan.  If any shares of Stock have been pledged as
collateral for indebtedness incurred by a Participant in connection with the
exercise of a Stock Option and such shares are returned to the Company in
satisfaction of such indebtedness, such shares shall again be available for
issuance in connection with future awards under the Plan.

          In the event of any merger, reorganization, consolidation,
recapitalization, Stock dividend, or other change in corporate structure
affecting the Stock, a substitution or adjustment may be made in (i) the
aggregate number of shares reserved for issuance under the Plan, and (ii) the
kind, number and option price of shares subject to outstanding Stock Options and
DERs granted under the Plan as may be determined by the Administrator, in its
sole discretion, provided that the number of shares subject to any award shall
always be a whole number.  Such other substitutions or adjustments shall be made
as may be determined by the Administrator, in its sole discretion; provided,
                                                                   -------- 
however, that with respect to Incentive Stock Options, such adjustment shall be
-------                                                                        
made in accordance with Section 424 of the Code.  An adjusted option price shall
also be used to determine the amount payable by the Company upon the exercise of
any Stock Appreciation Right or Limited Stock Appreciation Right associated with
any Stock Option.

          The aggregate number of shares of Stock for which Stock Options or
Stock Appreciation Rights may be granted to any individual during any calendar
year may not, subject to adjustment as provided in this Section 3, exceed 75% of
the shares of Stock reserved for the purposes of the Plan in accordance with the
provisions of this Section 3.

4.  ELIGIBILITY.

          Officers and other key employees of the Company or Subsidiaries who
are responsible for or contribute to the management, growth and/or profitability
of the business of the Company or its Subsidiaries and consultants and agents of
the Company or its Subsidiaries, shall be eligible to be granted Stock Options,
DERs, Stock Appreciation Rights, Limited Stock Appreciation Rights, Restricted
Stock awards, Deferred Stock awards or Performance Shares hereunder.  The
Participants under the Plan shall be selected from time to time by the
Administrator, in its sole discretion, from among the Eligible Employees and
consultants and agents recommended by the senior management of the Company, and
the Administrator shall determine, in its sole discretion, 

                                       5
<PAGE>
 
the number of shares covered by each award; provided, however, that Eligible 
                                            -----------------
Non-Employee Directors shall only be eligible to receive Stock Options as
provided in Section 5A.

5.  STOCK OPTIONS.

          Stock Options may be granted alone or in addition to other awards
granted under the Plan, including DERs as described in Section 5(11).  Any Stock
Option granted under the Plan shall be in such form as the Administrator may
from time to time approve, and the provisions of Stock Option awards need not be
the same with respect to each optionee.  Recipients of Stock Options shall enter
into a stock option agreement with the Company, in such form as the
Administrator shall determine, which agreement shall set forth, among other
things, the exercise price of the option, the term of the option and provisions
regarding exercisability of the option granted thereunder.

          The Stock Options granted under the Plan may be of two types: (i)
Incentive Stock Options and (ii) Non-Qualified Stock Options.

          The Administrator shall have the authority under this Section 5 to
grant any optionee (except Eligible Non-Employee Directors) Incentive Stock
Options, Non-Qualified Stock Options, or both types of Stock Options (in each
case with or without DERs, Stock Appreciation Rights or Limited Stock
Appreciation Rights), provided, however, that Incentive Stock Options may not be
                      --------  -------                                         
granted to any individual who is not an employee of the Company or its
Subsidiaries. To the extent that any Stock Option does not qualify as an
Incentive Stock Option, it shall constitute a separate Non-Qualified Stock
Option.  More than one option may be granted to the same optionee and be
outstanding concurrently hereunder.

          Stock Options granted under the Plan shall be subject to the following
terms and conditions and shall contain such additional terms and conditions, not
inconsistent with the terms of the Plan, as the Administrator shall deem
desirable:

      (1) Option Price.  The option price per share of Stock purchasable
          ------------                                                  
under a Stock Option shall be determined by the Administrator in its sole
discretion at the time of grant but shall not, in the case of Incentive Stock
Options, be less than 100% of the Fair Market Value of the Stock on such date,
and shall not, in any event, be less than the par value of the Stock.  The
option price per share of Stock purchasable under a Non-Qualified Stock Option
may be less than 100% of such Fair Market Value.  If an employee owns or is
deemed to own (by reason of the attribution rules applicable under Section
425(d) of the Code) more than 10% of the combined voting power of all classes of
stock of the Company or any Parent Corporation or Subsidiary and an Incentive
Stock Option is granted to such employee, the option price of such Incentive
Stock Option (to the extent required by the Code at the time of grant) shall be
no less than 110% of the Fair Market Value of the Stock on the date such
Incentive Stock Option is granted.

                                       6
<PAGE>
 
      (2) Option Term.  The term of each Stock Option shall be fixed by the
          -----------                                                      
Administrator, but no Stock Option shall be exercisable more than ten years
after the date such Stock Option is granted; provided, however, that if an
                                             --------  -------            
employee owns or is deemed to own (by reason of the attribution rules of Section
425(d) of the Code) more than 10% of the combined voting power of all classes of
stock of the Company or any Parent Corporation or Subsidiary and an Incentive
Stock Option is granted to such employee, the term of such Incentive Stock
Option (to the extent required by the Code at the time of grant) shall be no
more than five years from the date of grant.

      (3) Exercisability.  Stock Options shall be exercisable at such time
          --------------                                                  
or times and subject to such terms and conditions as shall be determined by the
Administrator at or after grant; provided, however, that, except as provided
                                 --------  -------                          
herein or unless otherwise determined by the Administrator at or after grant,
Stock Options shall become exercisable as to 25% of the shares subject to such
Stock Option on the first anniversary of the date of grant of the Stock Option,
and as to an additional 25% on each of the next three anniversaries of the date
of grant.  To the extent not exercised, installments shall accumulate and be
exercisable in whole or in part at any time after becoming exercisable but not
later than the date the Stock Option expires.  The Administrator may provide, in
its discretion, that any Stock Option shall be exercisable only in installments,
and the Administrator may waive such installment exercise provisions at any time
in whole or in part based on such factors as the Administrator may determine, in
its sole discretion.

      (4) Method of Exercise.  Subject to Section 5(3), Stock Options may be
          ------------------                                                
exercised in whole or in part at any time during the option period, by giving
written notice of exercise to the Company specifying the number of shares to be
purchased, accompanied by payment in full of the purchase price in cash or its
equivalent as determined by the Administrator.  As determined by the
Administrator, in its sole discretion, payment in whole or in part may also be
made in the form of unrestricted Stock already owned by the optionee, or, in the
case of the exercise of a Non-Qualified Stock Option, Restricted Stock or
Performance Shares subject to an award hereunder (based, in each case, on the
Fair Market Value of the Stock on the date the option is exercised); provided,
                                                                     -------- 
however, that in the case of an Incentive Stock Option, the right to make
-------                                                                  
payment in the form of already owned shares may be authorized only at the time
of grant.  Any payment in the form of stock already owned by the optionee may be
effected by use of an attestation form approved by the Administrator.  If
payment of the option exercise price of a Non-Qualified Stock Option is made in
whole or in part in the form of Restricted Stock or Performance Shares, the
shares received upon the exercise of such Stock Option (to the extent of the
number of shares of Restricted Stock or Performance Shares surrendered upon
exercise of such Stock Option) shall be restricted in accordance with the
original terms of the Restricted Stock or Performance Share award in question,
except that the Administrator may direct that such restrictions shall apply only
to that number of shares equal to the number of shares surrendered upon the
exercise of such option.  An optionee shall generally have the rights to
dividends and other rights of a stockholder with respect to shares subject to
the option only after the optionee has given written notice of exercise, has
paid in full for such shares, and, if requested, has given the representation
described in paragraph (1) of Section 11.

                                       7
<PAGE>
 
          The Administrator may require the voluntary surrender of all or a
portion of any Stock Option granted under the Plan as a condition precedent to a
grant of a new Stock Option.  Subject to the provisions of the Plan, such new
Stock Option shall be exercisable at the price, during such period and on such
other terms and conditions as are specified by the Administrator at the time the
new Stock Option is granted; provided, however, that should the Administrator so
                             --------  -------                                  
require, the number of shares subject to such new Stock Option shall not be
greater than the number of shares subject to the surrendered Stock Option.  Upon
their surrender, Stock Options shall be canceled and the shares previously
subject to such canceled Stock Options shall again be available for grants of
Stock Options and other awards hereunder.

      (5) Loans.  The Company may make loans available to Stock Option
          -----                                                       
holders in connection with the exercise of outstanding options granted under the
Plan, as the Administrator, in its discretion, may determine.  Such loans shall
(i) be evidenced by promissory notes entered into by the Stock Option holders in
favor of the Company, (ii) be subject to the terms and conditions set forth in
this Section 5(5) and such other terms and conditions, not inconsistent with the
Plan, as the Administrator shall determine, and (iii) bear interest, if any, at
such rate as the Administrator shall determine.  In no event may the principal
amount of any such loan exceed the sum of (x) the exercise price less the par
value of the shares of Stock covered by the option, or portion thereof,
exercised by the holder, and (y) any federal, state, and local income tax
attributable to such exercise.  The initial term of the loan, the schedule of
payments of principal and interest under the loan, the extent to which the loan
is to be with or without recourse against the holder with respect to principal
or interest and the conditions upon which the loan will become payable in the
event of the holder's termination of employment shall be determined by the
Administrator; provided, however, that the term of the loan, including
               --------  -------                                      
extensions, shall not exceed seven years.  Unless the Administrator determines
otherwise, when a loan is made, shares of Stock having a Fair Market Value at
least equal to the principal amount of the loan shall be pledged by the holder
to the Company as security for payment of the unpaid balance of the loan, and
such pledge shall be evidenced by a pledge agreement, the terms of which shall
be determined by the Administrator, in its discretion; provided, however, that
                                                       --------  -------      
each loan shall comply with all applicable laws, regulations and rules of the
Board of Governors of the Federal Reserve System and any other governmental
agency having jurisdiction.

      (6) Limits on Transferability of Options.
          ------------------------------------ 

          (a) Subject to Section 5(6)(b), no Stock Option shall be transferable
by the optionee otherwise than by will or by the laws of descent and
distribution or pursuant to a "qualified domestic relations order," as such term
is defined in the Employee Retirement Income Security Act of 1974, as amended
("ERISA"), and all Stock Options shall be exercisable, during the optionee's
lifetime, only by the optionee or in accordance with the terms of a qualified
domestic relations order.

          (b) The Administrator may, in its discretion, authorize all or a
portion of the options to be granted to an optionee to be on terms which permit
transfer by such optionee to (i) the spouse, qualified domestic partner,
children or grandchildren of the optionee and any other 

                                       8
<PAGE>
 
persons related to the optionee as may be approved by the Administrator
("Immediate Family Members"), (ii) a trust or trusts for the exclusive benefit
of such Immediate Family Members, (iii) a partnership or partnerships in which
such Immediate Family Members are the only partners, or (iv) any other persons
or entities as may be approved by the Administrator, provided that (x) there may
be no consideration for any transfer unless approved by the Administrator, (y)
the stock option agreement pursuant to which such options are granted must be
approved by the Administrator, and must expressly provide for transferability in
a manner consistent with this Section 5(6)(b), and (z) subsequent transfers of
transferred options shall be prohibited except those in accordance with Section
5(6)(a) or expressly approved by the Administrator. Following transfer, any such
options shall continue to be subject to the same terms and conditions as were
applicable immediately prior to transfer, provided that, except for purposes of
Sections 5(7), (8) and (9) and 11(3) hereof, the terms "optionee," Stock Option
holder" and "Participant" shall be deemed to refer to the transferee. The events
of termination of employment under Sections 5(7), (8) and (9) hereof shall
continue to be applied with respect to the original optionee, following which
the options shall be exercisable by the transferee only to the extent, and for
the periods specified under such sections unless the option agreement governing
such options otherwise provides. Notwithstanding the transfer, the original
optionee will continue to be subject to the provisions of Section 11(3)
regarding payment of taxes, including the provisions entitling the Company to
deduct such taxes from amounts otherwise due to such optionee. Any transfer of a
Stock Option that was originally granted with DERs related thereto shall
automatically include the transfer of such DERs, any attempt to transfer such
Stock Option separately from such DERs shall be void, and such DERs shall
continue in effect according to their terms. "Qualified domestic partner" for
the purpose of this Section 5(6)(b) shall mean a domestic partner living in the
same household as the optionee and registered with, certified by or otherwise
acknowledged by the county or other applicable governmental body as a domestic
partner or otherwise establishing such status in any manner satisfactory to the
Administrator. Stock options granted prior to December 1, 1996 may be amended to
provide for their transferability, subject to the foregoing conditions.

      (7) Termination by Death.  If an optionee's employment with the Company 
          --------------------                                       
or any Subsidiary terminates by reason of death, the Stock Option may thereafter
be immediately exercised, to the extent then exercisable (or on such accelerated
basis as the Administrator shall determine at or after grant), by the legal
representative of the estate or by the legatee of the optionee under the will of
the optionee, for a period of twelve months (or such shorter period as the
Administrator shall specify at grant) from the date of such death or until the
expiration of the stated term of such Stock Option, whichever period is shorter.

      (8) Termination by Reason of Disability.  If an optionee's employment
          -----------------------------------                              
with the Company or any Subsidiary terminates by reason of Disability, any Stock
Option held by such optionee may thereafter be exercised, to the extent it was
exercisable at the time of such termination (or on such accelerated basis as the
Administrator shall determine at the time of grant), for a period of twelve
months (or such shorter period as the Administrator shall specify at grant) from
the date of such termination of employment or until the expiration of the stated
term of such Stock Option, whichever period is shorter; provided, however, that,
                                                        --------  -------       
if the optionee dies 

                                       9
<PAGE>
 
within such twelve-month period (or such shorter period as the Administrator
shall specify at grant) and prior to the expiration of the stated term of such
Stock Option, any unexercised Stock Option held by such optionee shall
thereafter be exercisable to the extent to which it was exercisable at the time
of termination for a period of twelve months (or such shorter period as the
Administrator shall specify at grant) from the time of death or until the
expiration of the stated term of such Stock Option, whichever period is shorter.
In the event of a termination of employment by reason of Disability, if an
Incentive Stock Option is exercised after the expiration of the applicable
exercise periods under Section 422 of the Code, such Stock Option shall
thereafter be treated as a Non-Qualified Stock Option n.

      (9) Other Termination.  Except as otherwise determined by the
          -----------------                                        
Administrator, if an optionee's employment with the Company or any Subsidiary
terminates for any reason other than death or Disability, the Stock Option may
be exercised for a period of three months from the date of such termination, or
until the expiration of the stated term of such Stock Option, whichever period
is shorter.

      (10) Annual Limit on Incentive Stock Options.  To the extent that the
           ---------------------------------------                         
aggregate Fair Market Value (determined as of the date the Incentive Stock
Option is granted) of shares of Stock with respect to which Incentive Stock
Options granted to an Optionee under this Plan and all other option plans of the
Company, its Parent Corporation or any Subsidiary become exercisable for the
first time by the Optionee during any calendar year exceeds $100,000, such Stock
Options shall be treated as Non-Qualified Stock Options.

      (11) DERs.  The Administrator shall have the discretion to grant DERs
           ----                                                            
in conjunction with grants of Stock Options pursuant to this Section 5.  DERs
may be granted in either of two forms, "Current-pay DERs" and "Accrued DERs" and
the Administrator may condition the payment or accrual of amounts in respect
thereof subject to satisfaction of such performance objectives as the
Administrator may specify at the time of grant.  Assuming satisfaction of any
applicable conditions, Current-pay DERs shall be paid concurrently with any
dividends or distributions paid on the Stock during the time the related Stock
Options are outstanding in an amount equal to the cash dividend (or Stock or
other property hereby distributed) per share being paid on the Stock times the
number of shares subject to the related Stock Options.  Current-pay DERs are
payable in cash, Stock or such other property in the same manner as may be
distributed to shareholders.  Accrued DERs may be accrued in respect of cash
dividends only or cash dividends and the value of any Stock or other property
distributed to shareholders, as the Administrator shall determine at the time of
grant.  Assuming satisfaction of any applicable conditions, Accrued DERs shall
be accrued with respect to the related Stock Options outstanding as of the date
dividends are declared on the Company's Stock in accordance with the following
formula:

                                  (A x B) / C

under which "A" equals the number of shares subject to such Stock Options, "B"
equals the cash dividend per share or the value per share of the Stock or other
property being distributed, as the 

                                       10
<PAGE>
 
case may be, and "C" equals the Fair Market Value per share of Stock on the
dividend payment date. The Accrued DERs shall represent shares of Stock which
shall be issuable to the holder of the related Stock Option proportionately as
the holder exercises the Stock Option to which the Accrued DERs relate, rounded
down to the nearest whole number of shares. DERs shall expire upon the
expiration of the Stock Options to which they relate. The Administrator shall
specify at the time of grant whether dividends shall be payable or credited on
Accrued DERs. Notwithstanding anything to the contrary herein, Accrued DERs
granted with respect to Stock Options shall be accrued only to the extent of the
number of shares of stock then reserved and available for issuance under the
Plan in excess of the number of shares subject to issuance pursuant to
outstanding Stock Option, Accrued DER, Stock Appreciation Right, Limited Stock
Appreciation Right, Deferred Stock or Performance Share awards.

5A.  STOCK OPTIONS FOR ELIGIBLE NON-EMPLOYEE DIRECTORS.

          This Section 5A shall apply only to automatic grants of Stock Options
to Eligible Non-Employee Directors.

      (1) Each Eligible Non-Employee Director shall automatically be granted, 
upon becoming a director of the Company or any Subsidiary, a Non-
Qualified Stock Option to purchase 5,000 shares of Stock.  In addition, on the
day after the annual meeting of stockholders of the Company to be held in the
calendar year 1997, and on the day after each annual stockholders' meeting of
the Company thereafter during the term of the Plan, each Eligible Non-Employee
Director of the Company shall be granted a Non-Qualified Stock Option to
purchase 2,500 shares of Stock, together with accrued DERs with respect to such
Non-Qualified Stock Option.  The option price per share of Stock purchasable
under such Stock Option shall be 100% of the Fair Market Value on the date of
grant.  Such Stock Option shall become exercisable as to 25% of the shares
subject to such Stock Option on the first anniversary of the date of grant of
the Stock Option, and as to an additional 25% of the shares subject to such
Stock Option on each of the next three anniversaries of the date of grant.  To
the extent not exercised, installments shall accumulate and be exercisable in
whole or in part at any time after becoming exercisable but not later than the
date the Stock Option expires.  Exercise shall be by payment in full of the
purchase price in cash and no stock option shall be exercisable more than ten
years after the date of grant.  The aggregate number of shares of Stock that may
be granted to Eligible Non-Employee Directors pursuant to the Plan may not
exceed 150,000 shares.

      (2) Eligible Non-Employee Directors who receive grants of Stock Options
shall enter into a stock option agreement with the Company, which agreement
shall set forth, among other things, the exercise price of the option, the term
of the option and provisions regarding exercisability of the option granted
thereunder. The Stock Options granted under this section shall be Non-Qualified
Stock Options.

      (3) Non-Qualified Stock Options granted to Eligible Non-Employee Directors
hereunder shall be transferable only to the extent provided in Sections 5(6)(a)
and (b).

                                       11
<PAGE>
 
      (4) Accrued DERs shall be paid with respect to such Non-Qualified Stock
Options in accordance with the provisions of Section 5(11) above.

      (5) The Board may not amend, alter or discontinue the provisions of this
Section 5A more than once every six months other than to comport with changes in
the Code, ERISA and the rules thereunder or the federal securities laws and the
rules thereunder.

6.  STOCK APPRECIATION RIGHTS AND LIMITED STOCK APPRECIATION RIGHTS.

      (1) Grant and Exercise.  Stock Appreciation Rights and Limited Stock
          ------------------                                              
Appreciation Rights may be granted either alone ("Free Standing Rights") or in
conjunction with all or part of any Stock Option granted under the Plan
("Related Rights").  In the case of a Non-Qualified Stock Option, Related Rights
may be granted either at or after the time of the grant of such Stock Option.
In the case of an Incentive Stock Option, Related Rights may be granted only at
the time of the grant of the Incentive Stock Option.

          A Related Right or applicable portion thereof granted in conjunction
with a given Stock Option shall terminate and no longer be exercisable upon the
termination or exercise of the related Stock Option, except that, unless
otherwise provided by the Administrator at the time of grant, a Related Right
granted with respect to less than the full number of shares covered by a related
Stock Option shall only be reduced if and to the extent that the number of
shares covered by the exercise or termination of the related Stock Option
exceeds the number of shares not covered by the Stock Appreciation Right.

          A Related Right may be exercised by an optionee, in accordance with
paragraph (2) of this Section 6, by surrendering the applicable portion of the
related Stock Option.  Upon such exercise and surrender, the optionee shall be
entitled to receive an amount determined in the manner prescribed in paragraph
(2) of this Section 6.  Stock Options which have been so surrendered, in whole
or in part, shall no longer be exercisable to the extent the Related Rights have
been so exercised.

      (2) Terms and Conditions.  Stock Appreciation Rights shall be subject
          --------------------                                             
to such terms and conditions, not inconsistent with the provisions of the Plan,
as shall be determined from time to time by the Administrator, including the
following:

          (a) Stock Appreciation Rights that are Related Rights ("Related Stock
Appreciation Rights") shall be exercisable only at such time or times and to the
extent that the Stock Options to which they relate shall be exercisable in
accordance with the provisions of Section 5 and this Section 6; provided,
                                                                -------- 
however, that no Related Stock Appreciation Right shall be exercisable during
-------                                                                      
the first six months of its term, except that this additional limitation shall
not apply in the event of death or Disability of the optionee prior to the
expiration of such six-month period.

                                       12
<PAGE>
 
          (b) Upon the exercise of a Related Stock Appreciation Right, an
optionee shall be entitled to receive up to, but not more than, an amount in
cash or that number of shares of Stock (or in some combination of cash and
shares of Stock) equal in value to the excess of the Fair Market Value of one
share of Stock as of the date of exercise over the option price per share
specified in the related Stock Option multiplied by the number of shares of
Stock in respect of which the Related Stock Appreciation Right is being
exercised, with the Administrator having the right to determine the form of
payment.

          (c) Related Stock Appreciation Rights shall be transferable or
exercisable only when and to the extent that the underlying Stock Option would
be transferable or exercisable under paragraph (6) of Section 5.

          (d) Upon the exercise of a Related Stock Appreciation Right, the Stock
Option or part thereof to which such Related Stock Appreciation Right is related
shall be deemed to have been exercised for the purpose of the limitation set
forth in Section 3 on the number of shares of Stock to be issued under the Plan.

          (e) A Related Stock Appreciation Right granted in connection with an
Incentive Stock Option may be exercised only if and when the Fair Market Value
of the Stock subject to the Incentive Stock Option exceeds the exercise price of
such Stock Option.

          (f) Stock Appreciation Rights that are Free Standing Rights ("Free
Standing Stock Appreciation Rights") shall be exercisable at such time or times
and subject to such terms and conditions as shall be determined by the
Administrator at or after grant; provided, however, that no Free Standing Stock
                                 --------  -------                             
Appreciation Right shall be exercisable during the first six months of its term,
except that this limitation shall not apply in the event of death or Disability
of the recipient of the Free Standing Stock Appreciation Right prior to the
expiration of such six-month period.

          (g) The term of each Free Standing Stock Appreciation Right shall be
fixed by the Administrator, but no Free Standing Stock Appreciation Right shall
be exercisable more than ten years after the date such right is granted.

          (h) Upon the exercise of a Free Standing Stock Appreciation Right, a
recipient shall be entitled to receive up to, but not more than, an amount in
cash or that number of shares of Stock (or any combination of cash or shares of
Stock) equal in value to the excess of the Fair Market Value of one share of
Stock as of the date of exercise over the price per share specified in the Free
Standing Stock Appreciation Right (which price shall be no less than 100% of the
Fair Market Value of the Stock on the date of grant) multiplied by the number of
shares of Stock with respect to which the right is being exercised, with the
Administrator having the right to determine the form of payment.

                                       13
<PAGE>
 
          (i) Free Standing Stock Appreciation Rights shall be transferable or
exercisable subject to the provisions governing the transferability and
exercisability of Stock Options set forth in paragraphs (3) and (6) of Section
5.

          (j) In the event of the termination of an employee who has been
granted one or more Free Standing Stock Appreciation Rights, such rights shall
be exercisable to the same extent that a Stock Option would have been
exercisable in the event of the termination of the optionee.

          (k) Limited Stock Appreciation Rights may only be exercised within the
30-day period following a "Change of Control" (as defined in Section 10 below),
and, with respect to Limited Stock Appreciation Rights that are Related Rights
("Related Limited Stock Appreciation Rights"), only to the extent that the Stock
Options to which they relate shall be exercisable in accordance with the
provisions of Section 5 and this Section 6; provided, however, that no Related
                                            --------  -------                 
Limited Stock Appreciation Right shall be exercisable during the first six
months of its term, except that this additional limitation shall not apply in
the event of death or Disability of the optionee prior to the expiration of such
six-month period.

          (l) Upon the exercise of a Limited Stock Appreciation Right, the
recipient shall be entitled to receive an amount in cash equal in value to the
excess of the "Change of Control Price" (as defined in Section 10) of one share
of Stock as of the date of exercise over (A) the option price per share
specified in the related Stock Option, or (B) in the case of a Limited Stock
Appreciation Right which is a Free Standing Stock Appreciation Right, the price
per share specified in the Free Standing Stock Appreciation Right, such excess
to be multiplied by the number of shares in respect of which the Limited Stock
Appreciation Right shall have been exercised.

          (m) For the purpose of the limitation set forth in Section 3 on the
number of shares to be issued under the Plan, the grant or exercise of Free
Standing Stock Appreciation Rights shall be deemed to constitute the grant or
exercise, respectively, of Stock Options with respect to the number of shares of
Stock with respect to which such Free Standing Stock Appreciation Rights were so
granted or exercised.

7.  RESTRICTED STOCK, DEFERRED STOCK AND PERFORMANCE SHARES.

      (1) General.  Restricted Stock, Deferred Stock or Performance Share
          -------                                                        
awards may be issued either alone or in addition to other awards granted under
the Plan.  The Administrator shall determine the Eligible Employees to whom, and
the time or times at which, grants of Restricted Stock, Deferred Stock or
Performance Share awards shall be made; the number of shares to be awarded; the
price, if any, to be paid by the recipient of Restricted Stock, Deferred Stock
or Performance Share awards; the Restricted Period (as defined in Section 7(3))
applicable to Restricted Stock or Deferred Stock awards; the performance
objectives applicable to Performance Share or Deferred Stock awards; the date or
dates on which restrictions applicable to such Restricted Stock or Deferred
Stock awards shall lapse during such Restricted Period; and 

                                       14
<PAGE>
 
all other conditions of the Restricted Stock, Deferred Stock and Performance
Share awards. The Administrator may also condition the grant of Restricted
Stock, Deferred Stock awards or Performance Shares upon the exercise of Stock
Options, or upon such other criteria as the Administrator may determine, in its
sole discretion. The provisions of Restricted Stock, Deferred Stock or
Performance Share awards need not be the same with respect to each recipient.

      (2) Awards and Certificates.  The prospective recipient of a Restricted 
          -----------------------                                 
Stock, Deferred Stock or Performance Share award shall not have any rights with
respect to such award, unless and until such recipient has executed an agreement
evidencing the award (a "Restricted Stock Award Agreement," "Deferred Stock
Award Agreement," or "Performance Share Award Agreement," as appropriate) and
delivered a fully executed copy thereof to the Company, within a period of sixty
days (or such other period as the Administrator may specify) after the award
date. Except as otherwise provided below in this Section 7(2), (i) each
Participant who is awarded Restricted Stock or Performance Shares shall be
issued a stock certificate in respect of such shares of Restricted Stock or
Performance Shares; and (ii) such certificate shall be registered in the name of
the Participant, and shall bear an appropriate legend referring to the terms,
conditions, and restrictions applicable to such award, substantially in the
following form:

"The transferability of this certificate and the shares of stock represented
hereby are subject to the terms and conditions (including forfeiture) of the
NovaStar Financial, Inc. 1996 Executive and Non-Employee Director Stock Option
Plan and a Restricted Stock Award Agreement or Performance Share Award Agreement
entered into between the registered owner and NovaStar Financial, Inc.  Copies
of such Plan and Agreement are on file in the offices of NovaStar Financial,
Inc."

          The Company shall require that the stock certificates evidencing such
shares be held in the custody of the Company until the restrictions thereon
shall have lapsed, and that, as a condition of any Restricted Stock award or
Performance Share award, the Participant shall have delivered a stock power,
endorsed in blank, relating to the Stock covered by such award.

      (3) Restrictions and Conditions.  The Restricted Stock, Deferred Stock
          ---------------------------                                       
and Performance Share awards granted pursuant to this Section 7 shall be subject
to the following restrictions and conditions:

          (a) Subject to the provisions of the Plan and the Restricted Stock,
Deferred Stock or Performance Share award agreement, during such period as may
be set by the Administrator commencing on the grant date (the "Restricted
Period"), the Participant shall not be permitted to sell, transfer, pledge or
assign shares of Restricted Stock, Performance Shares or Deferred Stock awarded
under the Plan; provided, however, that the Administrator may, in its sole
                --------  -------                                         
discretion, provide for the lapse of such restrictions in installments and may
accelerate or waive such restrictions in whole or in part based on such factors
and such circumstances as the Administrator may determine, in its sole
discretion, including, but not limited to, the attainment 

                                       15
<PAGE>
 
of certain performance related goals, the Participant's termination, death or
Disability or the occurrence of a "Change of Control" as defined in Section 10.

          (b) Except as provided in paragraph (3)(a) of this Section 7, the
Participant shall have, with respect to the shares of Restricted Stock or
Performance Shares, all of the rights of a stockholder of the Company, including
the right to vote the shares, and the right to receive any dividends thereon
during the Restricted Period.  With respect to Deferred Stock awards, the
Participant shall generally not have the rights of a shareholder of the Company,
including the right to vote the shares during the Restricted Period; provided,
                                                                     -------- 
however, that dividends declared during the Restricted Period with respect to
-------                                                                      
the number of shares covered by a Deferred Stock award shall be paid to the
Participant.  Certificates for shares of unrestricted Stock shall be delivered
to the Participant promptly after, and only after, the Restricted Period shall
expire without forfeiture in respect of such shares covered by the award of
Restricted Stock, Performance Shares or Deferred Stock, except as the
Administrator, in its sole discretion, shall otherwise determine.

          (c) Subject to the provisions of the Restricted Stock, Deferred Stock
or Performance Share award agreement and this Section 7, upon termination of
employment for any reason during the Restricted Period, all shares subject to
any restriction as of the date of such termination shall be forfeited by the
Participant, and the Participant shall only receive the amount, if any, paid by
the Participant for such Restricted Stock or Performance Shares, plus simple
interest on such amount at the rate of 8% per year.

8.  AMENDMENT AND TERMINATION.

          Subject to the provisions of Section 5A(5), the Board may amend, alter
or discontinue the Plan, but no amendment, alteration, or discontinuation shall
be made that would impair the rights of a Participant under any award
theretofore granted without such Participant's consent, or that without the
approval of the stockholders (as described below) would:

      (1) except as provided in Section 3, increase the total number of shares
of Stock reserved for the purpose of the Plan;

      (2) change the employees or class of employees eligible to participate
in the Plan; or

      (3) extend the maximum option period under paragraph (2) of Section 5
of the Plan.

          Notwithstanding the foregoing, stockholder approval under this Section
8 shall only be required at such time and under such circumstances as
stockholder approval would be required under (a) Rule 16b-3 of the Act with
respect to any material amendment to any employee benefit plan of the Company or
(b) Sections 162(m), 280G or 422 of the Code.

                                       16
<PAGE>
 
          The Administrator may amend the terms of any award theretofore
granted, prospectively or retroactively, but, subject to Section 3, no such
amendment shall impair the rights of any holder without his or her consent.

9.  UNFUNDED STATUS OF PLAN.

          The Plan is intended to constitute an "unfunded" plan for incentive
compensation.  With respect to any payments not yet made to a Participant or
optionee by the Company, nothing contained herein shall give any such
Participant or optionee any rights that are greater than those of a general
creditor of the Company.

10.  CHANGE OF CONTROL.

          The following acceleration and valuation provisions shall apply in the
event of a "Change of Control" as defined in paragraph (2) of this Section 10:

      (1) In the event of a "Change of Control," unless otherwise determined by
the Administrator or the Board in writing at or after grant (including under any
individual agreement), but prior to the occurrence of such Change of Control:

          (a) any Stock Appreciation Rights outstanding for at least six months
and any Stock Options, including Stock Options granted under Section 5A, awarded
under the Plan not previously exercisable and vested shall become fully
exercisable and vested;

          (b) the restrictions applicable to any Restricted Stock, Deferred
Stock or Performance Share awards under the Plan shall lapse, and such shares
and awards shall be deemed fully vested; and

          (c) the value of all outstanding Stock Options (except Stock Options
granted under Section 5A), DERs (except DERs granted in conjunction with Stock
Options granted under Section 5A), Stock Appreciation Rights, Limited Stock
Appreciation Rights, and Restricted Stock, Deferred Stock and Performance Share
awards shall, to the extent determined by the Administrator at or after grant,
be cashed out by a payment in cash or other property, as the Administrator may
determine, on the basis of the "Change of Control Price" (as defined in
paragraph (3) of this Section 10) as of the date the Change of Control occurs or
such other date as the Administrator may determine prior to the Change of
Control.

      (2) For purposes of paragraph (1) of this Section 10, a "Change of
Control" shall be deemed to have occurred if, at any time following an initial
public offering of Common Stock by the Company:

          (a) any "person," as such term is used in Sections 13(d) and 14(d) of
the Act (other than the Company; any trustee or other fiduciary holding
securities under an employee benefit plan of the Company; or any company owned,
directly or indirectly, by the stockholders 

                                       17
<PAGE>
 
of the Company in substantially the same proportions as their ownership of Stock
of the Company) is or becomes after the Effective Date the "beneficial owner"
(as defined in Rule 13d-3 under the Act), directly or indirectly, of securities
of the Company (not including in the securities beneficially owned by such
person any securities acquired directly from the Company or its affiliates)
representing 25% or more of the combined voting power of the Company's then
outstanding securities; or

          (b) during any period of two consecutive years (not including any
period prior to the Effective Date), individuals who at the beginning of such
period constitute the Board, and any new director (other than a director
designated by a person who has entered into an agreement with the Company to
effect a transaction described in clause (a), (c) or (d) of this Section 10(2))
whose election by the Board or nomination for election by the Company's
stockholders was approved by a vote of at least two-thirds (2/3) of the
directors then still in office who either were directors at the beginning of the
period or whose election or nomination for election was previously so approved,
cease for any reason to constitute at least a majority thereof; or

          (c) the stockholders of the Company approve a merger or consolidation
of the Company with any other corporation, other than (A) a merger or
consolidation which would result in the voting securities of the Company
outstanding immediately prior thereto continuing to represent (either by
remaining outstanding or by being converted into voting securities of the
surviving entity), in combination with the ownership of any trustee or other
fiduciary holding securities under an employee benefit plan of the Company, at
least 75% of the combined voting power of the voting securities of the Company
or such surviving entity outstanding immediately after such merger or
consolidation or (B) a merger or consolidation effected to implement a
recapitalization of the Company (or similar transaction) in which no person
acquires more than 50% of the combined voting power of the Company's then
outstanding securities; or

          (d) the stockholders of the Company approve a plan of complete
liquidation of the Company or an agreement for the sale or disposition by the
Company of all or substantially all of the Company's assets.

      (3) For purposes of this Section 10, "Change of Control Price" means the
higher of (i) the highest price per share paid or offered in any transaction
related to a Change of Control of the Company or (ii) the highest price per
share paid in any transaction reported on the exchange or national market system
on which the Stock is listed, at any time during the preceding sixty day period
as determined by the Administrator, except that, in the case of Incentive Stock
Options and Stock Appreciation Rights or Limited Stock Appreciation Rights
relating to Incentive Stock Options, such price shall be based only on
transactions reported for the date on which the Administrator decides to cash
out such options.

                                       18
<PAGE>
 
11.  GENERAL PROVISIONS.

      (1) The Administrator may require each person purchasing shares pursuant
to a Stock Option to represent to and agree with the Company in writing that
such person is acquiring the shares without a view to distribution thereof. The
certificates for such shares may include any legend which the Administrator
deems appropriate to reflect any restrictions on transfer.

          All certificates for shares of Stock delivered under the Plan shall be
subject to such stock-transfer orders and other restrictions as the
Administrator may deem advisable under the rules, regulations, and other
requirements of the Commission, any stock exchange upon which the Stock is then
listed, and any applicable federal or state securities law, and the
Administrator may cause a legend or legends to be placed on any such
certificates to make appropriate reference to such restrictions.

      (2) Nothing contained in the Plan shall prevent the Board from adopting
other or additional compensation arrangements, subject to stockholder approval
if such approval is required; and such arrangements may be either generally
applicable or applicable only in specific cases. The adoption of the Plan shall
not confer upon any employee of the Company or any Subsidiary any right to
continued employment with the Company or a Subsidiary, as the case may be, nor
shall it interfere in any way with the right of the Company or a Subsidiary to
terminate the employment of any of its employees at any time.

      (3) Each Participant shall, no later than the date as of which the value
of an award first becomes includable in the gross income of the Participant for
federal income tax purposes, pay to the Company, or make arrangements
satisfactory to the Administrator regarding payment of, any federal, state, or
local taxes of any kind required by law to be withheld with respect to the
award. The obligations of the Company under the Plan shall be conditional on the
making of such payments or arrangements, and the Company (and, where applicable,
its Subsidiaries) shall, to the extent permitted by law, have the right to
deduct any such taxes from any payment of any kind otherwise due to the
Participant.

      (4) No member of the Board or the Administrator, nor any officer or
employee of the Company acting on behalf of the Board or the Administrator,
shall be personally liable for any action, determination, or interpretation
taken or made in good faith with respect to the Plan, and all members of the
Board or the Administrator and each and any officer or employee of the Company
acting on their behalf shall, to the extent permitted by law, be fully
indemnified and protected by the Company in respect of any such action,
determination or interpretation.

                                       19
<PAGE>
 
12.  EFFECTIVE DATE OF PLAN.

          The Plan became effective (the "Effective Date") on October 10, 1996,
the date the Company's stockholders formally approved the Plan.

13.  TERM OF PLAN.

          No Stock Option, Stock Appreciation Right, Limited Stock Appreciation
Right, Restricted Stock, Deferred Stock or Performance Share award shall be
granted pursuant to the Plan on or after the tenth anniversary of the Effective
Date, but awards theretofore granted may extend beyond that date.

                                       20