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Stock option valuation: Black-Scholes compared to a lattice binomial method

I referred in a previous post (See my post of July 25, 2007.) to a method for valuing stock options, which is called the binomial method. I just know in my bones that my loyal readers, all three of them, crave more information. So, here is an explanation of that calculation from the website of the New York State Society of CPAs.

“Historically, Wall Street has valued options using models such as Black-Scholes. Such models are primarily applicable to short-term publicly traded options, however, and may not be the best approach to valuing employee stock options, which tend to be longer term, nontransferable, and subject to various vesting requirements and forfeiture rules.

A recently discussed alternative endorsed by the current FASB proposal is the use of a ‘lattice’ binomial model which takes into consideration those characteristics associated with employee stock options.”

The rest of the piece explains the mathematics, which are not your garden-variety lattice.

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