How to hedge employee stock options

Discussion in 'Trading' started by new2this, May 23, 2009.

  1. new2this


    I am a participant in an employee stock option plan. The industry my company is in is Mining and metals. The plan has a 3 year vesting period and in addition requires my company to outperform the mean return of a basket of peer group companies for my options to vest. ie I get zero if my company falls below the mean return. The date for measuring this outperformance and vesting is Aug 2011.

    My company is currently successfully outperforming the basket of peers so the options are in the money. However, if this situation changes come Aug 2011 I stand to lose out on about $150k worth of stocks..

    So my question is can anyone suggest a hedging strategy I can use to compensate me for the scenario where my company's performance falls below the peer group mean returns.

    I realise this insurance will cost me money but am prepared to give up all/any upside in the $150k due to any increase in my company's stock price between now and aug 2011 to pay for the hedge.


    Any suggestions on strategy to use are much appreciated,
  2. There are companies that specialize in this stuff, unfortunately I don't know any, but I suggest doing some digging and trying to find them. Not sure if they would play for $150k but you never know.

    Alternatively, since your main risk is the company underperforming its peers, perhaps you could just short the stock and go long the peer group on appropriate size? You have margin call risk though if your company's stock outperforms significantly or gets taken over, so you'd have to work out the cost of a deep out-the-money LEAP call option.
  3. dnz


  4. new2this



    thanks for the reply.

    Just to be sure I understand your suggestion, are you suggesting I buying long dated call option on the peer group and sell long dated, out of the money call options on my company to help fund the hedge?

    When I looked at this there doesn't seem to be the volume of options contracts available in the market to cover $150k exposure - or am I misunderstanding something :confused:

    If anyone else is aware of a service provider who may be able to help me withthis I would appreciate the input.
  5. new2this


    thx DNZ - will check them out.
  6. Are the stocks of your company shortable?
    Are there options available?
    What do you mean by outperforming? Is this just stock price based?
    (And on a not serious note, if it's stock price based talk to Jonathan Lebed prior to the cutoff date, lol).
  7. new2this


    Are the stocks of your company shortable? Yes.
    Are there options available? Yes - although volumes available on long dated options seem to be are low.
    What do you mean by outperforming? Is this just stock price based? Based upon Total Shareholder Return - shareprice movement plus dividends.
  8. No I meant short the stock of your company and go long the peer group, so that you make money on the hedge if your firm underperforms. If it outperforms, you make money on your options.

    There is a risk that your company outperforms so much that you lose a shitload and get a huge margin call before you get your options. So it would make sense to buy an out-the-money long-term call option to protect against this risk. That will erode your return, but that's the price of insurance.
  9. I think you are long a pair ratio.
    You want to make money if the ratio goes up or down but you are willing to pay a little for that insurance. That by definition is a straddle.
    So it would be something like buying puts on your company and buying calls on the peer group.
    For the exact strikes and qty, I leave that to you, lol. That would probably be expensive because time is money in options and you expiration is far away.