We have been approached by a consultant regarding our ESOP (we are an S-Corp). We currently limit distributions to cash, but the consultant says we can amend the plan to distribute stock with a "call option" so that the company can decide when it can come up with the cash to buy the stock from the participant. I assume the stock would also require a "put" option.

Has anybody heard of this? Issues?

I do not know of any statutory authority for such a call option. You are correct, the participants would have a put option. The IRS has ruled that there can be an immediate demand for redemption of the stock upon distribution by an ESOP of an S corporation - see Rev. Proc. 2004-4 and 2003-23. But this is an IMMEDIATE demand for redemption upon distribution, not one where the plan sponsor gets to choose when it feels like demanding the stock.

I have a follow up question that relates to this situation. Assume that there is an immeidate redemption of the S-corp stock upon distribution. Is the corporation requied to issue the participant a K1?

You need to check IRC reg. 1.1377-1(a)(2). If it is really immediate, they get no K-1 as stock ownership is measured at the beginning of the day. So, if they only hold it for a small portion of the day, they are not a stockholder for purposes of allocating activity.