Callback options grant investors options based on a date when the value was less than current share price, allowing for an immediate return. While not illegal, there are ethical concerns. Option pullbacks are common in employee stock options, but opinions differ on their effectiveness. Some countries require reporting of option pullbacks and impose time limits on their use.
Callback options is a strategy in which options are granted to an investor based on a date when the value of those options was less than the current share price. While this type of activity is not considered illegal in most nations, there are questions in some quarters about its ethical implications. In actual practice, option pullbacks make it possible for investors who are granted the shares to earn an immediate return, since the previous share price has already been replaced by the most recent and highest price per share.
One of the most common situations in which option rollbacks take place is the assignment of company shares to employees. As part of the employee stock option, the company identifies a specific date in the recent past to serve as a benchmark for setting the value of those allocated shares. For example, XYZ Company may decide to grant an executive one thousand shares of preferred stock on December 31, when the shares are trading at a rate of $50 US dollars (USD) per share. Instead of using the current trading value, the company could decide to use the price the shares were trading at on December 1, which was $40 per share. This means that the executive immediately generates a return of $10 per share on each of those thousand shares.
In terms of organizing the paperwork, the issuer will make use of the actual date associated with the price used in the transaction. This means that even though the shares were assigned on December 31, the option rollback process requires documentation to be dated December 1, effectively justifying the price used in the transaction. As a result, the actual grant date associated with the shares is not the same as the grant date included in the documentation.
There is some difference of opinion about how effective this process really is, in terms of promoting greater efficiency among executives. Proponents view the immediate reward gained from using prior options as an incentive that encourages the recipient to be more committed to the employer. Opponents point out that once this immediate reward is given, the executive has little incentive to work harder and encourage growth of the business, a move that would likely result in increasing share value.
In some countries, any incidence of option pullback must be reported to the national regulatory agency that oversees trading and investment activity within that particular nation. Often, time limits are imposed that prevent the pullback process from using a price that applies to a date outside of a defined range. For example, the agency may allow a company to issue the shares to corporate executives at a price that applies to any date in the two calendar months preceding the date the shares are assigned, but would not allow the use of a price that back three months.
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