Tuesday, March 30, 2010

Revenge Of The Options

As the stock market crashed in late 2008 and early 2009, many stock options held by managements of both large and small caps were made worthless. Even today, after most stocks have rallied strongly from their lows, many stocks still remain far below their pre-recession levels, effectively reducing (after-the-fact) salaries of managements during the boom years. But it appears that many managements will not take these salary hits lying down, choosing instead to make up for them by increasing option payouts now that prices are recovering.

Consider Quest Capital (QCC), which offers financing to commercial and residential builders. On a single day in January 2010, the company issued over 4 million options to management, more than it has in the previous five years! Has management done such a great job that it deserved more options this year than it has ever before deserved?

What is happening here appears to be a sidestep of the extremely unpopular practice of re-pricing options. As Quest Capital's share price has dropped significantly, the underwater options are expiring worthless. More than ten million options were cancelled or have expired in the last two years, but a big chunk of them have now been replaced at a much lower price! More may be on the way, as the company has a plan that allows it to issue options for up to 10% of the company's outstanding shares.

The value of options outstanding for many companies has dropped significantly since the stock market crashed over a year ago. Shareholders must be on the lookout, however, for companies that are recycling those options at much lower prices. Not only does this lower the value of a company's shares, but it sends a message that management wants all the upside that options have to offer, without taking any risk that the upside may not materialize.

Disclosure: Author has a long position in shares of QCC

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