Valuing Stock Options
This calculator can be used to estimate the potential future value of stock options granted by your employer. The calculator requires a total of five inputs, including:
- The current stock price of the security, stated in terms of the price per share
- The annual stock option grant, this is the number of shares of stock included in the grant each year
- The strike price of the stock, which is how much you will pay to purchase one share of the stock if you were to exercise the option
- The anticipated growth in the value of the stock’s price each year
- The number of years over which you expect to receive a grant of stock
The calculator then provides the user with four outputs:
- The ending price per share of stock, which is a function of the starting price and the annual price growth rate
- The average strike price, which is a function of the starting strike price and the annual price growth rate
- The total shares of stock held via the grants, which is found by multiplying the annual grant times the number of years
- An estimate of the ending value of the stock options
Stock options versus grants
When a company grants an employee stock options, they are issuing to the employee a set number of shares at a set price – which is known as the strike price. The option allows the employee to purchase shares of the company’s stock at the strike price. If the market price of the stock rises above the strike price, the employee can purchase shares at the strike price and sell at the market price for a profit. The value of the option is the number of shares times the difference between the market price and the strike price.
Stock grants are designed to retain employees. A company grants an employee shares of stock, which will vest over a given timeframe. If the person receiving the grant is still an employee at the end of this timeframe, they keep the stock. If they leave the company before the designated timeframe, they lose their right to the stock grant. For example, a company might grant an employee 100 shares of stock that vest over a three-year timeframe. If the employee stays with the company for three years, they have a right to the 100 shares of stock – they now own 100 shares of stock.
Intrinsic value of options and grants
Stock grants will always have some intrinsic value, which is the current market price times the number of shares granted. Grants always have a positive intrinsic value because the employee does not have to pay for the stock. Stock options, on the other hand, may be worthless if the market price of the stock does not rise above the strike price. For example, if the employee purchases shares at a strike price of 30 per share and the market price is 25 per share, the employee would lose 5 for every share purchased.
This calculator is designed to account for the most common stock option scenario. One where the market price of the stock is below (sometimes significantly) the option’s strike price. Stock options are designed to motivate the leaders of the company to make decisions that will increase the value of the company, and therefore, the market price of the company’s common stock. When this occurs, the options they hold increase in value.