Using Black-Scholes to Put a Value on Stock Options

For years, companies that paid workers with stock options could avoid deducting the cost of those options as an expense. The rules changed in 2005, when the accounting industry updated its guidelines on share-based payments, in a rule called FAS 123(R).

Today, companies generally choose from one of two methods to value the cost of giving an employee a stock option: a Black-Scholes model, or a lattice model. Whichever one they choose, they must deduct the options expense from their profit, reducing per-share earnings.

The Black-Scholes model is a Nobel Prize-winning formula that can determine the theoretical value of an option on the basis of a series of variables. Because options grants to employees aren't replicas of exchange-traded options, the Black-Scholes rules require some modification for employee options. Continue reading about Black Scholes Stock Option Valuation ...