Headwinds for Employee Stock Options

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For the past five years, US equities have been on a stunning uptrend, with the S&P 500 Exchange Traded Fund (ETF: SPY) increasing from 94.55 for the week of June 1, 2009 to 164.80 for the week of June 3, 2013. This move has been good news for recipients of employee stock options (ESOs) and other forms of share-based payment. Recent comments by Federal Reserve Chairman Ben Bernanke have been met with dramatic responses in both equity and bond markets which may portend a coming correction in stocks across the board. Every participant in a share-based payment program should review the status of their vested awards in light of a possible reversal of the current equity trend.
Immediately after the crisis of 2008, which ushered in the “Great Recession,” The Fed adopted an expansionist monetary policy characterized by near-zero interest rates and massive injections of liquidity through treasury and MBS purchases. At the same time, low GDP growth and low levels of capital investment meant that torrents of newly-created cash surged into equity markets, causing an extended rally.

This past Tuesday, Chairman Bernanke remarked that the Fed’s current program of $85 Billion per month in bond purchases may be scaled back or tapered off in coming months. By Friday’s close, the DJIA had dropped below 15,000 and continues to sag in today’s trading (6/24/2013).

Normal market volatility notwithstanding, this selloff is accompanied by a brisk rise in Treasury yields. After languishing below 2.00% since April 2012, yield on the 10-year Note has advanced by over 50 basis points in the past two weeks. Falling bond prices are a prelude to falling stock prices as yield-hungry investors divert funds to relative safety and higher yields.

Although we have no crystal ball, it appears to us that the inevitable slowdown of the Federal Reserve printing press will have a dampening effect on equities and slower growth for the next two or three quarters. Holders of vested, in-the-money options should review their near-term cash requirements with the assistance of their accountants, attorneys, or financial advisors.

Markets are always changing and there is no “set it and forget it” program when it comes to investing or portfolio management.  Montgomery Investment Technology welcomes your comments. The commentary above is not intended as investment advice. Every investor should consult with licensed professionals before making investment decisions.

About the Author:

Greg is a Derivative Valuation Consultant with Montgomery Investment Technology, Inc. He holds a BS from Carnegie-Mellon University and a PhD in Chemical Engineering with a concentration in Applied Mathematics from Princeton University. His experience spans management at both public and privately held companies, as well as teaching finance at the university level. Greg is a Chartered Alternative Investment Analyst (CAIA) and a Financial Risk Manager (FRM)