If the stock price is trading lower than the grant price, the options are said to be underwater. Exercising options is useless if the employee can buy shares of the company stock for less on the open market. Most employees get NSOs, which are priced at a discount and taxed at ordinary income tax rates. A tax hit occurs once the options are exercised, so you pay either income tax or capital gains tax depending on whether your option is qualified, based on the grant price. Once you exercise the options, you can sell the shares after a short waiting period, or hold onto the shares and wait for the stock to increase further before selling.
Tips for Evaluating Stock Options in a Job Offer
Some investors hedge their bets by doing a bit of each. Once reserved only for the executive team, stock options became a popular form of compensation during the tech boom in the late s.
Back then, there were many tales of stock option success, and certain types of employees were looking for a sense of ownership in their workplace that went beyond the paycheck. By , so many options were underwater that they lost some of their appeal among the corporate masses. But in the world of start-ups, enough people got very wealthy from stock options that they remain a great tool for attracting early-stage talent.
There are a variety of reasons employers want to offer stock options. Vesting programs can help build longer-term loyalty among employees. The sense of shared ownership can foster a strong corporate culture. Employers often attach some incentive, such as an individual performance threshold or minimum number of years served, before employees become entitled to stock options. The promise of stock options also fosters a sense of responsibility among the workers who hold them.
For instance, employees are more inclined to become less tolerant of laziness from their peers because unproductive workers undermine the overall performance of the company, according to a Know W. Carey -- a publication of the W. Carey School of Business -- article.
8 Advantages of Incentive Stock Options You May Want to Know
Geri Terzo is a business writer with more than 15 years of experience on Wall Street. Throughout her career, she has contributed to the two major cable business networks in segment production and chief-booking capacities and has reported for several major trade publications including "IDD Magazine," "Infrastructure Investor" and MandateWire of the "Financial Times. Terzo is a graduate of Campbell University, where she earned a Bachelor of Arts in mass communication.
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Share on Facebook. Let's look at a real world example to help you understand how this might work. The employees can exercise the options starting Aug. On Aug. Here are the choices for the employee:. Whatever choice an employee makes, though, the options have to be converted to stock, which brings us to another aspect of stock options: the vesting period. In the example with Company X, employees could exercise their options and buy all shares at once if they wanted to.
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Usually, though, a company will spread out the vesting period, maybe over three or five or 10 years, and let employees buy so many shares according to a schedule. Here's how that might work:.
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And each year you're going to hope the stock price continues to rise. If you don't exercise the options within that period, you lose them. And if you are leaving a company, you can only exercise your vested options; you will lose any future vesting. One question you might have is: How does a privately held company establish a market and grant strike price on each share of its stock? This might be especially interesting to know if you are or might be working for a small, privately held company that offers stock options.
What the company does is to fix a price that is related to the internal value of the share, and this is established by the company's board of directors through a vote. Overall, you can see that stock options do have risk, and they are not always better than cash compensation if the company is not successful, but they are becoming a built-in feature in many industries.