CFA Practice Question

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CFA Practice Question

Stock options are dilutive when the average market price of the underlying stock is greater than the strike price of the option. True or False?
Correct Answer: True

Proceeds from redeeming the options are assumed to be used to purchase stock at the market price. If the market price is greater than the strike price, more shares will be issued from the options than could be repurchased with the option proceeds. The difference is added to the dilutive EPS denominator, lowering the ratio.

User Contributed Comments 9

User Comment
raution can someone explain the concept stated here.
pavlomel example:

You have an option to buy 1000 shares at strike price $25. Current market price is $50. Of course you exerise your option, so Company is forced to issue 1000 new shares to you. In return, you pay them 1000x25=$25000. Then, Company will use these $25K to buy back as much stocks from the market as they can at market price, which is $25000/$50=500 shares. Net effect is that number of shares on the market increased by 500 shares (1000 issued to you - 500 repurchased), hence dilution effect. If strike price is lower than market price, Company will always get less $ proceeds from you than it needs to buy back shares on the market.
rfvo N1 Pavlomel!!
wankoo Make it simple.

Dilutive=More common stocks=Lower EPS so when stock options are dilutive, they should be lower than the market price. Thus, true.
jpducros Stock options is like a Long Call.
moneyguy Very clear example pavlomel. Thanks.
LoveIvie thanks wankoo also
jonan203 stock options are essentially call options and are only convertible if:

Max(0,S-X); where S = underlying, X = strike

the option is worthless if the strike is greater than the price of the underlying (S<X) and at expiration would not be executed for common

in any instance where the underlying is greater than the strike (S>X), the option would be executed and any stock associated with such execution would dilute EPS
Freddie33 Thanks Wankoo. And nice name lmao
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