Question

You are manager of an airline company. The company issues stock options to its employees that have a fixed exercise price and term to maturity. Your company is very efficient and well managed compared to its competitors. However, due to a significant rise in the world price of oil, all airline stocks fall and your options expire “out of the money”.

Managers complain this is not fair. Discuss this viewpoint and suggest any solutions?

Answer 1

Let's understand the situation first:

Suppose the airline company has provided its employees with the option of purchasing its stocks at $100 per share (currently trading at $130) with a certain maturity period. However, due to rise in the prices of oil, the airline's stock prices falls to $90, therefore making the options "out of the money" or simply speaking worthless since the price that the employee would pay to purchase the stock by exercising its option would be greater than the price at which the employee can purchase stocks in the market. Given such a case, the first aspect that the employees need to realise is that the downfall of the stock is the result of a factor affecting the whole industry and not just the company. Such factors are usually uncontrollable in nature and the magnitude by which the airline company is affected by the price rise depends on the exposure that the company has to the price risk. If the exposure is high, the effect on the market price of the shares of the company is severe, if not , then the effect is nominal. One of the solutions that could be suggested is to wait and watch if the oil prices adjust itself until the maturity period, if the prices adjust itself and the employees find the options to be "at the money" or "in the money", they can exercise the options, if not, the employees should not exercise the options as it would cost them more. Additionally, employees need to realise that the option prices were valued at the time when the prices of oil were stable and administration has no part in controlling the market price of the share therefore they play no part in this situation.