Stock Options: Your Right (But Not Obligation) to Buy Company Stock

Stock options give you the right, but not the obligation, to buy a specific number of company shares at a predetermined price (the “exercise” or “strike” price) within a certain timeframe. Think of it like a coupon for company stock. They’re often used as a form of equity compensation—a way for companies to reward employees and attract top talent without spending immediate cash. They also allow employees to share in the company’s success.

Key Terms to Understand

• Grant Date: The day you receive the options. Mark this on your calendar! It’s crucial for tax purposes and vesting schedules.
• Vesting Schedule: A timeline that dictates when you actually own the options and can exercise them. They typically vest gradually over a period of time (often four years). [[Vesting]] [[Vesting Schedule]]
• Vesting Cliff: A period before any of your options vest. For example, a one-year cliff means you earn no options until you’ve worked for a year. [[Cliff Vesting]]
• Exercise Price (Strike Price): The price at which you can buy the shares. This is set on the grant date and usually below the market value at the time of grant, representing the potential upside. [[Exercise Price Strike Price What It Means for You]]
• Expiration Date: The deadline for exercising your options. If you don’t exercise them before this date, they become worthless. [[Expiration Date (for options)]] [[Grant Date vs Expiration Date Important Timelines]]
• Exercising: The act of purchasing the shares at the exercise price. [[Exercising Options]]
• Spread: The difference between the current market value and the option’s strike price. When the market price is higher than the strike price, your option is “in the money” and represents a profit opportunity.

Types of Stock Options

• Incentive Stock Options (ISOs): Offer potential tax advantages if certain holding period requirements are met. Typically only available to employees. [[ISO Incentive Stock Option]]
• Non-Qualified Stock Options (NSOs): Don’t have the same tax advantages as ISOs, but they’re often simpler. [[NSO Non-Qualified Stock Option]] [[Understanding Your Stock Options ISO vs NSO]]

What Happens When You Exercise?

You pay the exercise price for the shares. You can then hold these shares, or, if the company has gone public or there is a private market, you may be able to sell them. [[Selling Your Shares with Earlyasset The Process]]

Why Do Companies Offer Stock Options?

• Attracting and Retaining Talent: Options offer the potential for significant financial gain, making a company more attractive to potential employees and incentivizing current employees to stay.
• Alignment of Interests: By giving employees a stake in the company’s success, options encourage them to work hard and make decisions that benefit the company as a whole.
• Conserving Cash: Options allow companies to compensate employees without impacting their immediate cash flow.

Things to Consider

• Taxes: The tax implications of exercising and selling stock options can be complex and vary depending on the type of option (ISO or NSO). Consult a tax advisor. [[Capital Gains Tax]] [[Ordinary Income Tax on Equity Compensation]]
• Risk: The value of your options is directly tied to the company’s performance. If the company doesn’t do well, your options could become worthless.

It’s common to wonder…

• “What happens if I leave the company?” This depends on the company’s policy and your agreement, but you often have a limited time (e.g. 90 days) to exercise your options after leaving.
• “When is the best time to exercise?” This depends on a variety of factors, including your personal financial situation, the company’s performance, and tax implications. [[The Importance of Planning for Liquidity]] [[Life Events Liquidity When a Sale Makes Sense]]
• “How can I get an idea of what my options are worth?” Earlyasset provides tools like the Instant Offer to help you understand the potential value of your equity. [[Instant Offer Getting Indicative Pricing]] [[Portfolio Tracker Monitoring Your Private Equity]]

So here’s what we covered:

• Key terms related to stock options
• Different types of stock options
• What happens when you exercise your options
• Why companies offer stock options
• Things to consider, including taxes and risk
• Common questions about stock options