Options, warrants, and their equivalents are agreements that allow holders to purchase common shares at a fixed exercise price. Because these transactions bring new cash into the company, they cannot be modeled using the if-converted method. Instead, both frameworks mandate the use of the Treasury Stock Method.

The Treasury Stock Method assumes that any option or warrant exercises occur at the beginning of the period (or at the date of issuance, if later), and that the cash proceeds received from the holders are immediately used by the company to repurchase its own common shares from the open market at the current average market price.

Step 1: Compute Cash Proceeds = Total Number of Options  x  Exercise Price per Share
Step 2: Compute Shares Repurchased = Cash Proceeds  /  Average Open Market Share Price during Period
Step 3: Compute Net Share Expansion = Total Options Shares Issued  -  Shares Repurchased

The calculated Net Share Expansion value is added directly to the denominator of the Diluted EPS equation. The numerator (Net Income) remains completely unchanged under this method because option exercises do not impact corporate profit or loss.

Options and warrants only have a dilutive effect when the average market price of the common shares during the period exceeds the exercise price of the options (i.e., they are in-the-money). If they are out-of-the-money, they are ignored.