The Tax (Dis)Advantage Of A Firm Issuing Options On Its Own Stock

It is common for firms to issue or purchase options on the firm's own stock. Examples include convertible bonds, warrants, call options as employee compensation, or the sale of put options as part of share repurchase programs. This paper shows that option positions with implicit borrowing---such as put sales and call purchases---are tax-disadvantaged relative to the equivalent synthetic option with explicit borrowing. Conversely, option positions with implicit lending---such as compensation calls---are tax-advantaged. We also show that firms are better off from a tax perspective issuing bifurcated convertible bonds---bonds plus warrants---rather than an otherwise equivalent standard convertible. The put option sales which have been popular with some firms are like issuing debt with non-deductible interest and thus have a tax cost. For example, we estimate that in 1999 the tax cost to Microsoft of written puts was about $80m per year.