Theoretical Value (Of A Right)
Definition of 'Theoretical Value (Of A Right)'
The calculated value of a subscription right. The theoretical value of a right during the cum rights period - which is the interval after the announcement of the rights offering but before the stock trades on an ex-rights basis - is calculated by the formula:
(Stock Price - Rights subscription price per share) / # of rights required to buy one share + 1
The market value of a right is usually quite close to its theoretical value. Also known as intrinsic value of a right.
Investopedia explains 'Theoretical Value (Of A Right)'
For example, if the current stock price is $20, the subscription or exercise price is $15, and 4 rights are required to buy one share, the theoretical value of a right would be:
($20 - $15) / (4 + 1) = $1.
The theoretical value during the ex-rights period, when the rights are detached from the stock and trade on an independent basis, is slightly different than the value during the cum rights period. The formula in this case is:
(Stock Price - Rights subscription price per share) / # of rights required to buy one share).
Continuing with the above example, if the stock price in the ex-rights period is now $19.40, the theoretical value of a right would be:
($19.40 - $15) / (4) = $1.10.
The value of a right is determined by the same parameters that are used for pricing options, including the price of the underlying stock and its volatility, the rights subscription price, present interest rates, and time to expiration. A key difference is that unlike longer-dated options, rights have very little time value because of their relatively short lifespan.