[lelio]

As I understand it if a normal person buys an option there's someone out there that's on the hook if the price of the stock skyrockets.

But in the case of an exec getting options, who pays if the price of the stock goes up? That money to pay him off just doesn't materialize out of thin air. Is the number of options that a company grants to employees counted in the number of shares outstanding? They're kind of in a stock market limbo: they only exist for that split second you exercise them. Most of the time they're dead and not "costing" anyone anything.

[TopQuark]

who pays if the price of the stock goes up?

The company tyically (i) has some shares held or (ii) is authorized to issue them. In 2013, when you exercise at $40, the company will sell you the shares and receive from you $40. You will sell them, say at $200, and pocket the difference.

[TopQuark]

Is the number of options that a company grants to employees counted in the number of shares outstanding?

There are two answers to that of which I know one. Until recently, the companies were not requried to report the options granted, and some changes have been introduced by FASB. I am not an accountant, and do not know the details.

From the standpoint of finance, however, you do view the options as potentially deluting: if exercised, they will at that point increase the number of shares outstanding. How to take it into account is not a trivial mathematical problem.