Stock options are a popular form of compensation offered by many companies to their employees. Stock options allow employees to purchase company stock at a predetermined price, known as the strike price, within a certain time frame. In this article, we’ll take a closer look at how stock options work for employees.
What are Stock Options?
Stock options are a type of financial instrument that gives the holder the right, but not the obligation, to buy or sell a specific stock at a predetermined price, known as the strike price. The stock options are typically granted to employees as part of their compensation package, in order to incentivize them to stay with the company and contribute to its success.
There are two types of stock options: non-qualified stock options (NSOs) and incentive stock options (ISOs). NSOs are more common and allow employees to purchase company stock at a discounted price, while ISOs offer tax advantages but are subject to certain restrictions.
How Do Stock Options Work for Employees?
Stock options typically vest over a period of time, meaning that the employee has to work for the company for a certain amount of time before they can exercise their options. Once the options vest, the employee can purchase company stock at the predetermined strike price.
For example, let’s say an employee is granted 1,000 stock options with a strike price of $10 per share. The options vest over a period of four years, with 25% vesting each year. After the first year, the employee can exercise 250 options and purchase 250 shares of company stock for $10 per share. If the stock price has risen to $15 per share, the employee can sell the shares for a profit of $5 per share.
It’s important to note that stock options have an expiration date, which is typically 10 years from the date of grant. If the employee doesn’t exercise their options before the expiration date, the options expire worthless.
Tax Implications of Stock Options
The tax implications of stock options can be complex and depend on the type of option granted and how long the employee holds the stock. In general, NSOs are subject to ordinary income tax on the difference between the strike price and the fair market value of the stock at the time of exercise. ISOs, on the other hand, are subject to capital gains tax if the employee holds the stock for at least one year after exercising the options.
In summary, stock options are a form of compensation offered by many companies to their employees. Stock options allow employees to purchase company stock at a predetermined price, within a certain time frame. The options typically vest over a period of time and have an expiration date. The tax implications of stock options can be complex and depend on the type of option granted and how long the employee holds the stock. As with any investment, it’s important to understand the mechanics of how stock options work before entering into any trades.