A dynamic programming algorithm to value employee reload 
options in a utility maximization framework




Lau Ka Wo
Department of Computer Science
HKUST

November 21, 2003
11-11:50 AM
Room 3501, HKUST


Abstract
--------
The reload provision in an employee stock option is 
an option enhancement that allows the employee to pay the 
strike upon exercising the stock option using his owned 
stocks and to receive new "reload" stock options. 
The usual Black-Scholes risk neutral valuation approach cannot 
be adopted as the pricing vehicle for employee stock options, 
due to the non-transferability of the ownership of the options 
and the restriction on short selling of the firm's stocks 
as hedging strategy. 

In this talk, we present a general utility maximization framework 
and a dynamic programming algorithm to price non-tradable employee 
stock options with reload provision. The risk aversion of the employee 
enters into the pricing model through the choice of the utility function. 
We examine how the value of the reload options to the employees are 
affected by the number of reloads outstanding, the risk aversion level 
and personal wealth. In particular, we explore how the reload 
provision may lower the difference between the cost of granting the 
option and the private option value and improve the compensation incentive 
of the option award.   

This is  joint work with Prof. Y.K. Kwok.