Stock Option Valuation

How Stock Option Valuation Can Be Made As Accurate As Possible

Stock option valuation can give you an idea of the value of your holdings, which can be especially important if you are considering cashing in on your investment. There are more companies than ever before offering some type of stock option benefit as part of their remuneration package, partly because of the tax breaks inherent in the system, and partly because of the fact that the benefit can be offered for no initial outlay. What the companies are offering only becomes valuable if they, and the employees, of course, can create a rise in share price.

If you take stock options from a company which posts good results, resulting in a rise in share price, you will eventually have a difficult choice to make. Do you take the immediate windfall profits you are offered, or do you leave your investment in the company stock with the possibility of further appreciation? For many young executives trying to set up home and raise a young family, it can be so tempting to relieve some financial pressure by taking the early gains, but the choice should really be made based on market probabilities.

The way in which you decide whether or not it is the right time to sell is by using stock option valuation, allied to stop loss and probability assessment. To calculate the value of an option, two meters are used. The first is known as the intrinsic value, which is a measure of the gains the share has made since you had the option to buy it. If the option was to buy a share at six dollars, for example, and the prevailing market price is now ten dollars, then the intrinsic value of the option at that time is four dollars.

This is easy enough to understand, as four dollars is the profit you would make if you exercised the option at that time. You have the right, but not the obligation, to buy the stock at six dollars, and you can sell it for ten in the open market. The other part of the valuation equation is the time factor, because an option with longer to run is intrinsically more valuable. There is no guarantee, of course, that the price will continue to rise, but the possibility is certainly there.

Combining the results of both parts of the stock option valuation equation gives you the most accurate answer possible as to the true value of your options. If you are undecided as to whether to sell, consider putting a stop loss under the current market price, and waiting. If the price falls back, you get stopped out and the loss will be minimal, but you have an unlimited potential for profit. Assessing the probability of further gains using technical analysis is a useful complement to stock option valuation.

 

 

 

 

 

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