I am trying to find right model to value 'Rights shares'. I thought of options, is that the right approach? When I tested it some securities have a good match to rights time series price but others have some noticeable differences. I am wondering if I have to factor in the rights ratio or BB adjustment factor within my option model?

warrants

A stock warrant is just like a stock option because it gives you the right to purchase a company's stock at a specific price and at a specific date. However, a stock warrant differs from an option in two key ways:

1. A stock warrant is issued by the company itself
2. New shares are issued by the company for the transaction.

Unlike a stock option, a stock warrant is issued directly by the company. When a stock option is exercised, the shares usually are received or given by one investor to another; when a stock warrant is exercised, the shares that fulfill the obligation are not received from another investor, but directly from the company.


How are stock warrants different from stock options?

thanks for your reply ppauper. I was actually  inquiring about 'Rights' and not 'Warrants'

thanks for your reply ppauper. I was actually  inquiring about 'Rights' and not 'Warrants'

I would value  nil-paid rights as a warrant
with a rights issue, the company issues new stock and gives existing stock holders the right to buy that new stock. Warrants are also issued by the company which issues new stock for the transaction. You might notice that there's a similarity there.
Your question was how to value rights, and whether option theory was the correct approach, and you asked "I am wondering if I have to factor in the rights ratio or BB adjustment factor within my option model?"
I'm not sure what you're abbreviating by "BB" here, but warrant theory takes into account the dilution of shareholder value by the issue of new stock.

OK, but a rights issue has the following features:

1. The purchaser has the right (but not the obligation) to purchase the underlying stock at somepoint in the future
2. The Stock is in the company that has issued the right
3. The rights are for newly issues shares for the company in the transaction

What extra economic factor is there in a rights issue that is not in a warrant?

It's an option on a stock with a (stock) dividend. You need to take into account that the rights get exercises and hence causes a stock dividend.

edit: it depends a bit on the type of discount you get as a rights holder: can you buy the stock at a fixed price, or with a 10% discount?

Also, after the announcement you should have seen a dividend effect in the regular options, it's like an unexpected new dividend announcement.

here's an example from the UK,
national grid
stock price before announcement, 620p
2 new shares at 335p each (the strike-price, a discount of 44% to the price before the announcement) for every 5 shares owned
after the announcement, the share price dropped 43½, or 7%, to 576½p, so the strike price is deep in the money.

there will be a date-of-record for the rights, meaning if the shares are transferred before that date, the rights go with them and if they are transferred after that date, the rights do not get transferred. The price quoted after that date is "ex-rights"

Good example. Since it's deep in the money the optionality effect is very limited.
That drop, was that after handing out the rights (the price of the stock ex-rights)? If so the fail value shoud have been (5*620+2*335*e(-rt))/7 +/-= 538

yes, in this instance, the date-of-record was close-of-business the day before the announcement.
company announcement