Of course, whether the owner comes out ahead by exercising early depends on how the underlying stock performs during the holding period, on dividends, on voting rights, and so on. Publicly traded call options need not be exercised in order to realize the profits from an increase in the price of the underlying security, because they can be sold to another investor, who receives the rights associated with the contract. Executive or employee stock options do not have this advantage, since they are usually nonmarketable. However, the basic determinants of the value of traded options are also relevant to the value of any option-type contract. Depending on the purpose of the valuation assignment, adjustments to the value of the option may be relevant.
Volatility is an important factor in many option valuation models.
As volatility increases, the chance that a stock will do very well or very poorly increases. Since the employee owns a call option, he would be expected to benefit from price increases but to be protected from the downside risk since he has nothing to lose. But, for many reasons, volatility is not a critical factor in the valuation of employee incentive stock options because of their many restrictions. Ordinary income tax rates apply to the gain if the stock is sold within one year and capital gains tax rates apply thereafter. While volatility is an important factor in the valuation of publicly traded stock options, its impact on the value of employee stock options is not clear.