What Is Spring Loading?
Spring loading is an option-granting practice in which options are granted to employees at a time that precedes a positive news event. This is a controversial practice as it allows employees to potentially book instant profits after the news event. It is not illegal but it does bear a resemblance to trading on insider information, which is illegal.
The opposite, called bullet-dodging, is the practice of delaying an options grant until after negative corporate news is released. In this way, the stock price falls, and the option grants are based on the lower prices, making them more favorable to the employee.
- Spring loading is a practice in which options are given to employees ahead of an expected positive news event, such as a product launch or quarterly results.
- Management times the granting of options so that employees can benefit from the bump in stock price that usually follows good news.
- Because there is often a lag between the time an option is granted and when it is vested, news can impact the profitability of the option.
- Spring loading is controversial because, although legal, it does share similarities to insider trading, which is illegal.
How Spring Loading Works
Spring-loading options is a controversial practice because it borders on unethical behavior, if not outright illegal activity. Because options strike prices tend to be derived from the stock price the day the grant is made, these employee stock options should be "at the money." That means the options should have strike prices equal to or very close to the price of the underlying stock that day.
Theoretically, executives and other highly-valued employees should benefit from options-based compensation only if their performance increases shareholder value. Therefore, critics of spring-loaded options state that allowing the option holder to gain instant profit defeats the purpose of option-based compensation.
However, others claim that the effects of spring loading are minimal, as most option grants have a vesting period, which prevents the holder from realizing his or her position for a period of time. In this case, the option might be out of the money long before the investor can exercise it.
Insider trading is the buying or selling of a security by someone who has access to material nonpublic information about the security. In spring loading, management is taking action in the financial markets ahead of the release of previously non-public information it already perceives as market moving. This is the very definition of trading on insider information.
While proponents of spring loading claim that there is no way to know in advance how the market will react to positive or negative news, the chances that the market will react positively to positive news are rather high. Critics of spring loading then will argue that the release of non-public information with potential market-moving implications (i.e., insider information also cannot guarantee the market will indeed move).
However, the main point is that management, who are the ultimate insiders, know they will release positive news and take an action in the public markets before they actually release it.
While spring loading remains legal, it still appears to be a shady practice.