As I had indicated in my last Blog (Part 3), in this, our final blog of the Series “Is it Time” I would like to discuss intrinsic value and time value, by using a specific example from an executive that I have recently worked with.
Lets talk Intrinsic Value and Time Value!
As I had mentioned in the past, the intrinsic value of an option is the amount that exceeds the exercise price of the option. For example: If the exercise price of an option is $25/share and the stock is trading at $40/share the intrinsic value is $15/share, times the number of shares being exercised.
The time value of an option is the theoretical upside potential of the option going up in value due to the price of the stock going up. As I have mentioned in past blogs, the further away and option is from expiration the greater the time value.
These two values combined, make up what is referred to as the Black Scholes value or the total value of an option.
In my previous blog, I had used an example using the profit percentage which only factors in the intrinsic value. While the time value is not a value that can be cashed out, it needs to be factored in when deciding “is it time” to exercise.
In a recent analysis of a company executive, we determined he had several different options that were issued over the past 10 years, of which most of them had a high intrinsic value because the current stock price was much higher than the grant price. However, the options that were closest to expiration had the lowest time value.
In this executive’s case, the company was trading at 36.25/share and he had options that were issued in September 2003, that will expire in September 2013, with an exercise price of 12.60/share. The time value was less than 1% of the total Black Scholes value, indicating that it was time to exercise these options. In addition, he had some options that were issued in July 2007, with an exercise price of 20.50/share, due to expire in July 2017. Because the options do not expire for another four years, the time value was about 15% of the Black Scholes value, indicating the executive may not need to take immediate action in exercising these options.
This is a hypothetical example and is not representative of any specific investment. This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
Dan’s Moral: It is important to determine both the intrinsic value and time value in determining “is it time “when exercising options.
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