In the 1990s, a number of companies which had experienced sharp stock price declines, "repriced" previously-awarded employee stock options. Repricing consisted of resetting the options' strike prices to the current stock price (so as to bring them closer to the money). Suppose a company awards at-the-money stock options to its employees and decides it will reprice them if the stock price falls 50% from the initial award date. Then, the employee stock option is equivalent to a portfolio of
A) A vanilla call and a forward-starting call.
B) A knock-out and a knock-in barrier call option.
C) A knock-out call and a forward-strarting call.
D) A cliquet.

Question

Quizplus · Accepted Answer

The employee stock option described is equivalent to a combination of a knock-out and a knock-in barrier call option. The knock-out component ceases to exist if the stock price falls 50%, effectively "knocking out" the original option. The knock-in component becomes active only if the stock price falls 50%, representing the repricing mechanism that adjusts the strike price to the current lower stock price, making it a new, viable option for the employee.

In the 1990s, a Number of Companies Which Had Experienced