**Question:** OptionTech Company reported net income of $2.3 million for the year ended 30 June 2009 and had a weighted average of 800,000 common shares outstanding. At the beginning of the fiscal year, the company has outstanding 30,000 options with an exercise price of $35. No other potentially dilutive financial instruments are outstanding. Over the fiscal year, the company’s market price has averaged $55 per share. Calculate the company’s basic and diluted EPS.

While I know the formula for treasury method, I don’t quite get the intuition behind it. Specifically, here are my questions:

a) With exercise price of $35 and 30K options outstanding, OptionTech would get $1,050,000. Now, if it reinvests this money by buying (back) common stock at $55, wouldn’t the average number of outstanding shares go down? The formula states that we need to subtract ($35*30000/$55) = 19,091 shares from 30K shares to get **how many additional shares are issued.** So, the denominator will be 800K + 30K - 19091. However, I would argue that we should subtract 19090 from 800K because these many shares are being bought back. Isn’t it? I am not quite sure about the idea that WACSO (weighted average com. shares out.) increases by 30K-19090 = 10909.

b) This method also assumes that we are talking about put options and not call option, in which case we would have a negative outflow because OptionTech would have to pay the money to buy the stock. Is this assumption always true ? I looked at Schweser and Curriculum and didn’t find any discussion on call or put options. So, this is another question I thought of discussing.

Can someone please help me? I am a bit stuck.