Question

The CEO of a growing cyber-security firm was awarded 25,000 stock options as part of her pay package. She can exercise the options -turn them into stock- in two years. The company’s stock price was $35.00 per share at the time of the stock option grant. Shortly after the option award was received, she went to an investment banking firm and bought put options at a strike price of $35.00. The option expires in two years.

(i) What does the put option do for the CEO? Carefully explain why your stated result occurs.

(ii) Stock options and stock ownership are included in compensation packages to create incentives for CEOs to create value for shareholders. Does this put option purchase change those incentives? If so, how?

(iii) If you were a shareholder in this company, would you want to be informed about these types of transactions by the CEO?

Answer 1

1. A put option is a contract giving the owner (in this case CEO of cyber security firm) the right, but not the obligation, to sell a specified amount of an underlying security at a pre-determined price within a specified time frame. So by purchasing option at a strike price of $ 35, CEO is ensuring that after 2 years, if stock price is below $ 35, he can sell his options at a strike price of $ 35. So for e.g. Stock price after 2 years is $ 20, CEO has a right to sell it at @ $35. So he is protecting himself against future price variation by purchasing option.
2. Stock options and stock ownership are included in compensation packages to create incentives for CEOs and to create value for shareholders respectively. Put option purchase does not change incentives. It is only a guard/precaution taken by purchasing put option.
3. If I would have been shareholder of this company, I would be interested to know about these transactions by CEO. If CEO is purchasing put option at same strike price, he is not confident enough to create value for shareholder.