Options Trading Tutorial

What is the difference between the fair value method and intrinsic value method?

The question is refering to accounting for stock options in company financial statements.

Public Comments

1. fair value is the market optimal value of the stock, intrinsic value is the true value of the stock or company
2. They are the same thing. The essence of each is an attempt to determine the true value of a company's stock. The only difference is who is using them.
3. The intrinsic value method is the difference between the current market price of the stock and the exercise price (or "strike price") of the option. Most employee options are issued at more than the current market price, so their intrinsic value is zero. However, this ignores their time value - they remain usable to some point in the future, and it is possible that an increasing stock price will make it profitable to exercise the options. The true fair value is the intrinsic value plus the time value. Obviously calculating the value of the possibility that the option will be valuable in the future is complicated. Strike price, volatility, and time until the option expires must all be considered. Therefore mathematical models, such as Black Scholes or the binomial method, must be employed. Public companies are now required to recognize compensation expense for employee and other compensatory stock options using the fair value method.