Employee Reload Options: Pricing, Hedging, and Optimal Exercise

Philip Dybvig and Mark Loewenstein

The Review of Financial Studies, 2003, vol. 16, issue 1, 145-171

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.

Date: 2003
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The Review of Financial Studies is currently edited by Itay Goldstein

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