Stock-based compensation, or stock options, require an employee to perform services for a period of time (the vesting period) to have the right to purchase the company's stock . Options must be exercised on a certain date (exercise date) and the underlying stock can be purchased at a specified price (exercise, target or option price). For companies, options need to be valued because their costs need to be allocated starting from the date the option is issued and throughout the employee's vesting period. The Black-Scholes method is a formula typically used to value stock options. The formula requires the input of certain variables to calculate the value of the stock option. While the equation is complex, the variables needed to calculate the option's value are straightforward.

## Using the Black-Scholes Method to Calculate Stock Based Compensation

Perform a search for "Black-Scholes calculator" to obtain a list of calculators that are available online. Note that stock option values are dependent on the accuracy of the variables that are entered into the formula and option values may vary depending on the calculator used. Overall, the answer the calculator provides is an estimate of the the stock option's value.

Obtain the exercise price of the stock and holding period from your stock-based compensation documents. The exercise price and length of time until options can be exercised can be obtained from documentation provided by your employer, who has the details on the stock options it is offering you.

Research and obtain the current price of the stock and the annual risk-free rate of return. The stock's current price and the annual risk-free interest rate can be obtained from any reliable news source that provides daily interest rate and stock price information. For example, for the risk-free interest rate, use the interest rate on a Treasury security that has a maturity date comparable to the stock option's holding period.

Compute the annualized volatility of the stock price. This variable is the most complex of all the variables because it requires high-level math computations to arrive at the value. Search for a "stock price volatility calculator" online that facilitates the annualized volatility computation. Note that for an annual volatility value, you need to input a stock's daily closing price for one year. It is also possible to substitute a daily price interval for a shorter period, such as a week or month. The value, when expressed as a percentage, can be divided by 100 to convert it to a decimal or if expressed as a decimal, multiplied by 100 to convert to a percentage.

Enter the variables in the correct format into the correct data entry fields on the calculator and the calculator's formula should produce a value for you. The formula produces a value for the purchase of one share of stock. To get the full value of the stock options, multiply the calculator's value by the number of shares that the option allows you to purchase.

#### Tips

Choose a calculator that applies to your situation. For example, some calculators calculate the value on European options and others take into consideration the payment of dividends.

#### Warnings

The basic Black-Scholes method does not take into account the payment of dividends. If your company pays dividends, this affects the value of your stock option. The Black-Scholes method assumes that variables remain constant over the holding period (stock price volatility and interest rates actually vary over time) There are other economic pricing models besides Black-Scholes that can be used to calculate the value of stock options.

#### References

- "Financial: CPA Exam Review"; DeVry/Becker Educational Development Corp; 2009
- 25 Years of Programming; Black Scholes Stock Option Stock Option Valuation Calculator; Oct. 22, 2010

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