Vicky Henderson (The Oxford-Man Institute), “Executive Stock Options: Portfolio Effects”, Fédération des Banques Françaises Seminar on Investment Banking and Financial Markets, Toulouse : IDEI, March 12, 2012, 12:30–13:45, room MF 323.
Executives compensated with stock options generally receive grants periodically and so on any given date, may have a portfolio of options of differing strikes and maturities on their company’s stock. Non-transferability and trading restrictions in the company stock result in the executive facing unhedgeable risk. We employ utility based pricing to analyse the optimal exercise thresholds for each option, option values and cost of the options to shareholders. Portfolio interaction effects mean that each of these differ, depending on the composition of the remainder of the portfolio. We demonstrate that the exercise threshold for a particular option can be discontinuous at the time that the option's position in the exercise order changes. In particular, the cost to shareholders of an option portfolio is lowered relative to its cost computed on a per-option basis. The model can explain a number of empirical observations - which options are attractive to exercise first, how exercise changes following a new grant, and early exercise. Joint with Jia Sun and Elizabeth Whalley (WBS).