We Know: How Stock Options Work

What Are Stock Options?

Stock options are given to you by an employer, and they consist of the rights to buy a specified number of shares of your company's stocks during a specified time period and, most importantly, at a price set by your employer. Typically, this price is considerably less than market value. They may be offered by both privately and publicly held companies.

Stock options are essentially another benefit your company can offer to attract and retain good workers, and to get them to take ownership interest in the company. If the company is a start-up, it's also a good way to attract skilled workers at a lower salary than these workers would normally expect.

How Can I Use Stock Options At A Profit?

Stock options generally carry inherent risk, but risk you can control to some extent by performing well for your company. The best thing you can do is know exactly what your rights are with the stock: when you can exercise your options, when you can convert, when your vesting period ends, and whether there is an expiration date. Plan your stock option movements on paper well before the time comes for you to exercise them.

When you're vested, you don't have to buy stock you have optioned; instead, you can often sell these options to someone else. So if you have a strike price on your stock of $6, but the stock is selling on the open market at $10 a share, the $4 (66%) profit on the stock is almost certainly attractive enough for a broker to purchase your options. Some companies won't let you sell options, but you can still talk to a broker about borrowing the money to buy the options, using stock purchased as collateral, and then reselling the stock to them to pay back the money. If you're not sure how to work this, speak with a stockbroker.

Stock Option Vocabulary

  • Grant or Strike Price - the price the company sets on the stock.
  • Converting Stock - buying optioned stock at grant price, then selling it at market price.
  • Exercising Stock Options - the employee's decision to purchase stocks at the grant price.
  • Vesting Period - Period of time during which you are allowed to purchase optioned stock on a schedule. Most companies will grant a certain amount of stock as options (freezing the price), but the employee may only exercise those options after a certain period of employment.
  • Expiration Date - date beyond which you can no longer purchase stock options you were granted.

What Else Should I Know?

  • Stock options come as non-qualified stock options or as incentive stock options (ISOs); know what kind you have, and learn the tax and usage rules behind the one you hold.
  • When stock options are part of your incentive package, your company is expecting you to take real ownership in the company; hard work on your part can add up to great profits in the long run.
  • Make certain you research and understand the tax ramifications of stock options and the exercising of them. It can really impact your income.

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