What are they?

An option becomes an underwater option if the current price of the shares under option has fallen below the price payable on the exercise of the option. Underwater options cause concerns when there is no reasonable prospect of share price recovery in the short or medium term, eg two to five years.

When do underwater options appear?

Underwater options commonly arise if after an option is granted:

1. •

   there is a bear market where share prices fall generally

2. •

   specific events affect a particular sector, eg bank shares in the early stages of the 2008 financial crisis, or in the aftermath of the EU referendum on 23 June 2016, when the FTSE 250 index dropped sharply, although it later recovered

3. •

   there is war or a natural or other disaster, eg oil companies shares after a major oil spill

4. •

   there is lack of confidence in a particular company or its management, eg following highly publicised criticism of Board members

Why is this a problem?

For the option holder, the option has