A stock option gives an employee the advantage to buy a specified number of shares in the organization that they work for at a set price over a number of years. This price that the option is offered is referred to as a “grant” price. This “grant” price is usually the market value of the shares at the time the employees are granted that opportunity to receive the stock option. Those employees that have received the grant hope that the market value of the shares will later increase and thus benefit from the grant.
This program is perceived as a flexible way of sharing the company’s ownership with employees. This thus calls for high performance of employees as they feel attached to the company they are working for. It also attracts and retains a motivated workforce.
However, the option is not a strategy that would work for a company that its future is not certain as members and staff of the company would take that opportunity to sell their shares to avoid total loss of their investment.
In the calculation of the employee stock option, we follow the following steps.
Valuing Outstanding Stock Options.
This can be valued by using the information of the company’s annual report. Using HP as our case study we begin by valuing the employee stock options using the black-Scholes option pricing method. To calculate the Black-Scholes value, we combine the information with our estimates of the following parameters.
Weighted average characteristics of outstanding stock option.: this is provided by the annual report and 10-k SEC filings.
Risk-free rate: The appropriate risk-free rate is the rate associated with the risk-free zero-coupon security with the same maturity as the option.
Volatility: This refers to the standard deviation of the underlying stock.
Dividend yield: This equals next year’s expected dividend per share divided by the share price.