What Exactly Are Stock Options?

Oct 10, 2023 By Triston Martin

Exchange-traded options and employee stock options are the two categories of stock options that are available. This discussion is going to center on the second option. Employee stock options are a kind of equity compensation that, if vested, provide the holder the right to purchase a certain number of firm shares at a predetermined price. The term "vesting" refers to the moment in which you acquire legal ownership of your options and are afterward entitled to put them to use (purchase company shares).

You may better align your interests with your company's ones by taking advantage of stock options. If the share price of your firm continues to rise, the value of your options will rise along with it, giving you additional motivation to contribute to your company's success.

The Mechanics behind Employee Stock Options

The grant date, which is the day you get a stock option contract from your company, is the point at which everything gets underway. The agreement specifies how many firm shares you are permitted to buy at a certain price (the special price, sometimes referred to as the exercise price) after meeting certain conditions, such as delaying the purchase until a specific period (the vesting date). It will also establish the expiry date, so you will know how much time you have left to exercise your options when the date is determined. You have the right to exercise your stock options whenever and wherever you see fit, but you are under no obligation. Employee stock options may come in a variety of forms.

Stock Options

As long as you continue to work for the firm after the vesting period, you can exercise your options at any point in time up to the expiration date. In most cases, this period may last for as long as ten years. Check the small print of your options contract to determine the time frame you have to exercise your options if you leave your current job. This time frame is often known as the "post-termination exercise period."

Whether or Not the Choices You Have Are Valuable

If your options do not have any value, then there is no need for you to exercise them. When this occurs, we say the person is "in the money." This situation arises when the "strike price" of your stock options, also known as the "exercise price," is lower than the current market price of the shares of your firm that are being traded on the exchange. In this scenario, you have the opportunity to exercise your options and make a purchase of business shares at a price that is lower than the strike price. The profit you would make from this process is referred to as the "bargain element," and it is possible to realize it by selling the shares in question on the stock market.

Whether or Not Your Firm Is Open to the Public

It is also important to consider whether or not your firm is held privately or is listed publically. Because shares of private firms are not traded on stock exchanges, you will need to pay for the purchase and the exercise of your option out of your funds (instead of being able to sell shares and cover your cost). You will also be exposed to the risk of holding onto illiquid shares, which means that it may be a long time before the company makes an initial public offering or some other event that would allow you to cash out your investment.

If your firm is still private but has filed for an initial public offering, now would be a good time to think about exercising any incentive stock options you have. To be eligible for preferential tax treatment, an ISO must be held for at least one year after it has been exercised and for at least two years after it has been granted.

Whether It Is Feasible in Your Current Economic Circumstances

When it comes to many different financial choices, the optimal time to accomplish anything is when it works for both you and the specific objectives that you have set for yourself. If your current income is sufficient to pay all of your outgoing costs, you may not need any extra funds from exercising your options or selling your shares. You could also be entitled to receive deferred compensation for a period, which would allow you to delay the process of exercising your options until a later date.

Whether or Not It Makes Sense in Terms Of Your Tax Situation

You can be subject to the standard income tax, the tax on capital gains, and the alternative minimum tax depending on the kind of employee stock options you own. These taxes are in addition to the alternative minimum tax. You will want to assess the tax consequences of exercising your options and continuing to hold on to business shares before selling them, in addition to ensuring that it is compatible with your long-term financial objectives and immediate need for income.

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