On May 31 a company's stock price is 70. One million shares...

On May 31 a company's stock price is $$\$ 70$$. One million shares are outstanding. An executive exercises 100,000 stock options with a strike price of $$\$ 50$$. What is the impact of this on the stock price?

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Key Concepts

Employee Stock Options

Employee stock options give employees the right to purchase shares at a predetermined price, usually set below the current market price to provide an incentive. When exercised, these options can lead to an increase in the number of shares outstanding and, as a result, a dilution in the ownership stake of existing shareholders.

Treasury Stock Method

The Treasury Stock Method is used to assess the dilutive effect of instruments such as stock options on the number of outstanding shares. This method assumes that the proceeds from exercising the options are used to repurchase shares at the current market price, resulting in a net increase in the share count that reflects the dilution impact.

Dilution

Dilution is the reduction in the ownership percentage and earnings per share for existing shareholders that occurs when new shares are issued. When stock options are exercised, the resulting increase in the total number of outstanding shares spreads the company’s earnings over a larger base, potentially decreasing the value attributable to each share.

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