Options accounting treatment


Investors buy call options if they think that the price of the underlying will go up and buy put options if they think the price of the underlying will go down. The price paid for acquiring the right to buy is called the call option premium. Whether the investor has the right to buy or to sell depends on which type of option the investor buys.

The purchaser of a call option has the right to buy the underlying asset. The purchaser of a put option has the right to sell the underlying asset. Note that puts and calls are mutually exclusive. A call option does not offset a put option and vice versa. In the National Stock Exchange, India, the quotes are available for the current month, near month and far month. For example, when investors trade in early May, they get quotes for May, June and July. The settlement period is the last Thursday of the relevant month.

So, if an investor buys 1 lot of May-X1 — Rs. A put option is the right, but not an obligation to sell something at a fixed price — the strike price at anytime within the specified time period.

The price paid for acquiring the right to sell is called the put option premium. When the investor buys a put, then the investor has the right to sell the underlying.

Note that the investor is dealing with different instruments here. The investor is buying a put instrument that gives the right to sell a different and distinct instrument which is the underlying asset.

For tax purposes, FIN 44 compensation charges are deductible to the company if the options are non-qualified options, but are not deductible if the options are incentive stock options. The entire fair value of the vested options is included in the purchase price to be allocated to the assets acquired.

However, the purchase price will include only the portion of the value of the unvested options equal to the fair value of such options less any allocation to unearned compensation. When stock options include an automatic vesting provision so that the options vest automatically upon a change in control, the acquirer avoids FIN 44's compensation charges that would otherwise drag down earnings in periods following the transaction.

However, automatic vesting upon a change in control can make employee retention more challenging for the acquirer. Tango has three tranches of unvested options outstanding as show in the spreadsheet below. What are the fair values of Tango's vested and unvested options? What value should be recorded as unearned compensation on the combined company's pro forma balance sheet? Download the solution to this problem.

Intrinsic Value FIN Unearned Compensation FIN Noncontrolling Interest Tax Considerations.