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Option
Model Assumptions
The screenshot in Figure 2 below illustrates the assumptions input on the 'Option Assumptions' sheet. Figure 2. The inputs into the Binomial Model. The input assumptions define the model computation behavior and valuation. The output values are shown for in the yellow fields: the key outputs are the Per Option Valuation and the Imputed Life. The Binomial Lattice model requires a set of inputs to produce the output data points:
The Binomial Lattice model creates a wide array of potential outcomes for stock prices and option exercise behavior using these input assumptions. The SubOptimal Exercise factor assumption informs the model when an option grantee can be expected to exercise their available shares and when the computed stock price exceeds this value (SubOptimal Exercise factor x Option Strike price). The Volatility input for each year informs the model on how much the stock price will increase or decrease in each year throughout the term. The selected Lattice model defines how the entered volatility data is used to create up/down stock price values throughout the contractual term (see the Volatility Tool for more information). The Dividend Yield is deducted against the stock price at the end of the annual term to adjust for dividends received by stockholders, but not by option holders. Finally, the Vesting Schedule and blackout inputs control the number of options available for exercise in each year. The result of all of this processing is a tree structure illustrated in Figure 1. Each potential outcome that creates an exercise will produce (and value) the number of vested options at the prevailing stock price less the strike price. If the stock never reaches the SubOptimal price but is higher than strike price at the end of the contractual term, the option will then be assumed to have exercised at that final value. Options that are "not in the money" at the end of the contractual term are valued at 0. Each exercise on a given outcome branch will have a year and value that produces an NPV based on the input assumption RiskFree rate to create a presentvalue of the potential future exercise. Each such outcome is then averaged along with outcomes that never exercise due to below strike price outcomes. This sheet also includes record keeping entries to organize and manage multiple grants and other features to prevent accidental changes. The following information is tracked for each grant:
To help make using the model as straightforward as possible, help text is available for the inputs with the buttons marked with . The volatility help window is shown in the Figure 3 screenshot below. Figure 3. The Volatility inputs into the Binomial Model and a Help screen for Volatility. Multiple values are entered for the Volatility for each year to allow the user to define stock behavior over the contractual life. When you are ready to create a valuation, use the 'Update Model' button to take the assumptions and create the Binomial Lattice model valuation. The model creates a detailed and dataintensive set of stock pricing and option exercise scenarios to produce this valuation. The first step in the calculation is to test the inputs for invalid data. If any inputs are out of range, an error message indicates what input is incorrect and the accepted range for that assumption. If all of the inputs are within the correct range, the model is computed and the data entered into the data output fields. 
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