Hey guys.
I’m kind of confused with the logic behind the in the money and out of the money while using the treasury stock method. Some examples doesn’t have a logic (at least for me). Let me put one from Investopedia:
"Consider a company that reports 100,000 basic shares outstanding, $500,000 in net income for the past year, and 10,000 in-the-money options and warrants, with an average exercise price of $50. The average market price for the shares in the last year was $100. Using the basic share count of the 100,000 common shares, the company’s basic EPS is $5 calculated as the net income of $500,000 divided by 100,000 shares. However, this number ignores the fact that 10,000 shares can be immediately issued if the in-the-money options and warrants are exercised.
Applying the treasury stock method, the company would receive $500,000 in exercise proceeds, calculated as 10,000 options and warrants times the average exercise price of $50, which it can use to repurchase 5,000 common shares on the open market at the average stock price of $100."
My questions are:
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Why would I exercise the option when the exercise price is lower than the average market price? Is it because it is a call option?
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If it is a call option, it doesn’t make any sense to receive $500,000 to then “hypothetically” repurchase at $100. Thoughts?
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Why if it is in the money (making a profit) it is dilutive? Shouldn’t be the other way around?
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In the exercises, they never tell you if it is a call or put option. Thoughts?
Hope you guys can clarify my misunderstanding!
Best!