Modeling Dilution from RSUs, Options and Warrants

A company has 100 million shares outstanding and reports $50 million of net income — $0.50 basic earnings per share. But employees are also holding 10 million stock options and 5 million unvested RSUs that will eventually become real shares. If all of those vest and get exercised, the same $50 million of earnings gets divided among more shares, and EPS drops. Diluted EPS exists precisely to show investors that lower, more realistic number, before it actually happens.

Why options dilute less than their raw count suggests

An RSU vesting into a share doesn't require the employee to pay anything, so each vested RSU adds roughly one new share to the count. A stock option, though, requires the holder to pay a strike price to exercise it — and accounting assumes the company uses that cash to buy back shares at the current market price, partially offsetting the new shares issued.

$$\text{Net new shares} = N_{\text{options}} \times \left(1 - \frac{K}{P}\right)$$

In words: the number of options outstanding, times the fraction of the current share price that isn't recovered as buyback proceeds — where $K$ is the strike price and $P$ is the current stock price. The deeper the option is in the money (the bigger the gap between price and strike), the closer this gets to a full 1-for-1 dilution.

Worked example

A company has 100 million basic shares, $50 million net income, 10 million options outstanding with a $20 strike price, and the current stock price is $50.

1. Net new shares from options: $10 \times (1 - 20/50) = 10 \times 0.6 = 6$ million.
2. Diluted share count: $100 + 6 = 106$ million (ignoring RSUs for simplicity here).
3. Basic EPS: $50 / 100 = 0.50$, i.e. $0.50.
4. Diluted EPS: $50 / 106 \approx 0.47$, i.e. $0.47.

If the stock price were $25 instead of $50 — options barely in the money — the same calculation gives net new shares of $10 \times (1 - 20/25) = 2$ million, only a third as dilutive, because there's much less "free" value in each option to offset with buyback proceeds.

What this means in practice

Diluted EPS is what analysts and the company itself report as the headline number precisely because it reflects the real, ongoing dilution shareholders face from an active equity compensation program. Companies that grant equity awards heavily but don't buy back enough stock to offset them see share counts creep up year after year, quietly diluting existing holders even while reported net income grows.