Southwest Airlines 2015 Annual Report Download - page 111

2014, and 2013, participants under the plan purchased 597 thousand shares, 792 thousand shares, and
1.5 million shares at average prices of $36.40, $23.17, and $12.03, respectively. The weighted-average
fair value of each purchase right under the ESPP granted for the years ended December 31, 2015, 2014,
and 2013, which is equal to the ten percent discount from the market value of the Common Stock at the
end of each monthly purchase period, was $4.04, $2.68, and $1.34, respectively.
Taxes
A portion of the Company’s granted options qualify as incentive stock options for income tax
purposes. As such, a tax benefit is not recorded at the time the compensation cost related to the options
is recorded for book purposes due to the fact that an incentive stock option does not ordinarily result in
a tax benefit unless there is a disqualifying disposition. Grants of non-qualified stock options result in
the creation of a deferred tax asset, which is a temporary difference, until the time that the option is
exercised. Due to the treatment of incentive stock options for tax purposes, the Company’s effective
tax rate from year to year is subject to variability.
10. FINANCIAL DERIVATIVE INSTRUMENTS
Fuel Contracts
Airline operators are inherently dependent upon energy to operate and, therefore, are impacted by
changes in jet fuel prices. Furthermore, jet fuel and oil typically represent one of the largest operating
expenses for airlines. The Company endeavors to acquire jet fuel at the lowest possible cost and to
reduce volatility in operating expenses through its fuel hedging program. Although the Company may
periodically enter into jet fuel derivatives for short-term timeframes, because jet fuel is not widely
traded on an organized futures exchange, there are limited opportunities to hedge directly in jet fuel for
time horizons longer than approximately 24 months into the future. However, the Company has found
that financial derivative instruments in other commodities, such as West Texas Intermediate (“WTI”)
crude oil, Brent crude oil, and refined products, such as heating oil and unleaded gasoline, can be
useful in decreasing its exposure to jet fuel price volatility. The Company does not purchase or hold
any financial derivative instruments for trading or speculative purposes.
The Company has used financial derivative instruments for both short-term and long-term time frames,
and primarily uses a mixture of purchased call options, collar structures (which include both a
purchased call option and a sold put option), call spreads (which include a purchased call option and a
sold call option), put spreads (which include a purchased put option and a sold put option), and fixed
price swap agreements in its portfolio. Although the use of collar structures and swap agreements can
reduce the overall cost of hedging, these instruments carry more risk than purchased call options in that
the Company could end up in a liability position when the collar structure or swap agreement settles.
With the use of purchased call options and call spreads, the Company cannot be in a liability position
at settlement, but does not have coverage once market prices fall below the strike price of the
purchased call option.
The Company evaluates its hedge volumes strictly from an “economic” standpoint and thus does not
consider whether the hedges have qualified or will qualify for hedge accounting. The Company defines
its “economic” hedge as the net volume of fuel derivative contracts held, including the impact of
positions that have been offset through sold positions, regardless of whether those contracts qualify for
hedge accounting. The level at which the Company is economically hedged for a particular period is
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