Question

A prospective employee must choose between a $5,000 cash bonus, or 3,000 options to buy Telstar stock at $35.00 per share at her fifth anniversary with the firm. One option allows the employee to buy one share of Telstar.

What if the employee decided that the option was a better deal, but didn’t want all of their financial wealth (as well as human capital or job) tied to the fortunes of Telstar. Assuming the employee works at Telstar for at least 5 years and accepts the option grant, what option strategies can be employed to protect the value of the stock options? You can assume that both long-term call and put options on Telstar with maturity up to 6 years are currently traded.

Answer 1

By exercising the 3000 option deal , employee is going to benefit in long term if the stock prices goes up and has the risk of stock prices going down.

To hedge the stocks , employee can buy PUT option on stock of Telstar at strike price of 35$ per share. This way employee will lock the current benefit.

Lets say, stock price goes up than PUT option will lapse. Otherwise if stock prices goes down , value of put option will increase to compensate the loss . This way portfolio is hedged in long term.