Underwater Option Exchanges: ASC 718 Compliant Valuation Methods for Options Subject to an Exchange Transaction

This Issue Brief reviews the challenges associated with valuing underwater options subject to an exchange transaction. Due to the characteristics of underwater options, it is generally not appropriate to use the Black-Scholes formula in the same manner it is used to value newly granted, at-the-money options. The valuation challenge concerns estimation of an expected term for partially- or fully-vested underwater options. The ASC 718 compliant approach is to use a lattice model in performing this task.

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