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What Is Stock Option Valuation?

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  • Written By: K.C. Bruning
  • Edited By: John Allen
  • Last Modified Date: 24 November 2016
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Stock option valuation is the multilayered process of determining the value of a stock option. This includes finding the cost of giving an option. Some of the methods used to accomplish this are the binomial and Black-Scholes models. The ultimate goal is to determine the fair value of the option at the time it is offered. Stock option valuation is commonly used by employers and employees when considering the value of a compensation package.

One part of the stock option valuation process is to find the intrinsic value of the stock. This is the actual, as opposed to market, value of the option. It is calculated by comparing the estimated future value of the stock with the current price. If the stock does not come out ahead, then it has no intrinsic value. In essence, the goal is to incorporate the cost of having the stock into the valuation in order to find a true value.

Stock option valuation also includes making projections for the value of the stock, as much of its value is linked to its potential. An analysis of past performance, including patterns of activity, can reveal much about the future prospects for a stock. It can also be useful to analyze the current market situation in order to determine what trends are developing and what known outside influences could do to change the value of the stock.

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The binomial operations pricing model is a common method of stock option valuation. It is also know as the lattice model. The method uses the performance of underlying elements of the options, such as individual stocks or groups of investments that make up and index, to determine value over time. It uses a formula that determines possible value at several different points in time.

Another common method of stock option valuation is the Black-Scholes model. It is a complex formula made up of simple variables such as interest rates, intrinsic value, and factors that indicate a probable change in the market, also known as market volatility. The equation is meant to demonstrate how the cost of the option changes over time.

There are several online calculators which can be used to perform a stock option valuation. As these tools can be of varying quality, it is often best to research multiple options before using them to determine value. Online forums, industry publications, and financial professionals can be useful resources for determining the best calculator.

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