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Employee Reload Options: Pricing, Hedging, and Optimal Exercise

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  • Philip H. Dybvig
  • Mark Loewenstein

Abstract

Reload options, call options granting new options on exercise, are popularly used in compensation. Although the compound option feature may seem complicated, there is a distribution-free dominant policy of exercising reload options whenever they are in the money. The optimal policy implies general formulas for numerical valuation. Simpler formulas for valuation and hedging follow from Black--Scholes assumptions with or without continuous dividends. Time vesting affects the optimal policy, but numerical results indicate that it is nearly optimal to exercise in the money whenever feasible. The results suggest that reload options produce similar incentives as employee stock options and share grants. Copyright 2003, Oxford University Press.

Suggested Citation

  • Philip H. Dybvig & Mark Loewenstein, 2003. "Employee Reload Options: Pricing, Hedging, and Optimal Exercise," The Review of Financial Studies, Society for Financial Studies, vol. 16(1), pages 145-171.
    • Handle: RePEc:oup:rfinst:v:16:y:2003:i:1:p:145-171
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    Citations

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    Cited by:

    1. Sircar, Ronnie & Xiong, Wei, 2007. "A general framework for evaluating executive stock options," Journal of Economic Dynamics and Control, Elsevier, vol. 31(7), pages 2317-2349, July.
    2. Jussi Keppo & Lones Smith & Dmitry Davydov, 2006. "Optimal Electoral Timing: Exercise Wisely and You May Live Longer," Cowles Foundation Discussion Papers 1565, Cowles Foundation for Research in Economics, Yale University.
    3. Wei Xiong & Ronnie Sircar, 2004. "Evaluating Incentive Options," Econometric Society 2004 North American Winter Meetings 253, Econometric Society.
    4. repec:dau:papers:123456789/13098 is not listed on IDEAS
    5. Jun Ma, 2011. "Pricing of a reload employee stock option under severance risk," Quantitative Finance, Taylor & Francis Journals, vol. 11(8), pages 1233-1244.
    6. de Meza, David & Webb, David C., 2003. "Principal agent problems under loss aversion: an application to executive stock options," LSE Research Online Documents on Economics 24676, London School of Economics and Political Science, LSE Library.
    7. Olaf Korn & Clemens Paschke & Marliese Uhrig-Homburg, 2012. "Robust stock option plans," Review of Quantitative Finance and Accounting, Springer, vol. 39(1), pages 77-103, July.
    8. Lim, Terence & Lo, Andrew W. & Merton, Robert C. & Scholes, Myron S., 2006. "The Derivatives Sourcebook," Foundations and Trends(R) in Finance, now publishers, vol. 1(5–6), pages 365-572, April.
    9. Eikseth, Hans Marius & Lindset, Snorre, 2011. "Backdating executive stock options--An ex ante valuation," Journal of Economic Dynamics and Control, Elsevier, vol. 35(10), pages 1731-1743, October.
    10. Min Dai & Yue Kuen Kwok, 2005. "Valuing employee reload options under the time vesting requirement," Quantitative Finance, Taylor & Francis Journals, vol. 5(1), pages 61-69.
    11. Susana Álvarez-Díez & J. Baixauli-Soler & María Belda-Ruiz, 2014. "Are we using the wrong letters? An analysis of executive stock option Greeks," Central European Journal of Operations Research, Springer;Slovak Society for Operations Research;Hungarian Operational Research Society;Czech Society for Operations Research;Österr. Gesellschaft für Operations Research (ÖGOR);Slovenian Society Informatika - Section for Operational Research;Croatian Operational Research Society, vol. 22(2), pages 237-262, June.
    12. Jonathan Ingersoll, 2006. "Valuing reload options," Review of Derivatives Research, Springer, vol. 9(1), pages 67-105, January.
    13. repec:dau:papers:123456789/9550 is not listed on IDEAS
    14. An Chen & Markus Pelger & Klaus Sandmann, 2013. "New performance-vested stock option schemes," Applied Financial Economics, Taylor & Francis Journals, vol. 23(8), pages 709-727, April.
    15. Grasselli, Matheus & Henderson, Vicky, 2009. "Risk aversion and block exercise of executive stock options," Journal of Economic Dynamics and Control, Elsevier, vol. 33(1), pages 109-127, January.
    16. Dai, Min & Kwok, Yue Kuen, 2008. "Optimal multiple stopping models of reload options and shout options," Journal of Economic Dynamics and Control, Elsevier, vol. 32(7), pages 2269-2290, July.
    17. Brian J. Hall & Thomas A. Knox, 2002. "Managing Option Fragility," NBER Working Papers 9059, National Bureau of Economic Research, Inc.
    18. Brian J. Hall & Thomas A. Knox, 2004. "Underwater Options and the Dynamics of Executive Pay‐to‐Performance Sensitivities," Journal of Accounting Research, Wiley Blackwell, vol. 42(2), pages 365-412, May.
    19. Elayan, Fayez A. & Pukthuanthong, Kuntara & Roll, Richard, 2004. "To Expense or not to Expense Employee Stock Options: The Market Reaction," University of California at Los Angeles, Anderson Graduate School of Management qt6zd6953v, Anderson Graduate School of Management, UCLA.

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