How Do Stock Options Work?

To make money is one of the things you learn when you do an investment.  But it is not a matter of investing your money.  Of course, you should be clever enough in making an investment.  In order to fully satisfy your goal in making money, you should consider the company where you are going to invest.  Thus, you should choose a company you truly believe in and completely trust, aside from it being a stable company in the market.

Stock Options will address the problem.   Stock options are presented by the company you are working.  Stock options will be considered as a high form of motivation regarding compensation especially if your focus is on how to make money.    Surely, you would like to make that company be successful in its own mission if you own a part of it.

Before discussing how stock options work, let us first know the meaning of an option.  An option is something that gives you the right, however with no obligation in buying a share of stock or any other security for a specific price or before a definite date.   You will have to make a decision if and when you are really desirous to buy those shares. Remember that almost all option agreements have also their dates of expiration.  You will be forfeiting your right to purchase those share if you will not exercise your option on the said date.

How about stock options?  Stock options give you the right to buy a specific number of shares of the company’s stock at a certain price at a specified time in the future.  Your right exists for a fixed period of time.  Once you are given the option, you will receive a communication regarding the number of shares you may buy, the exercise price and the term of the option.

We have two types of stock options namely, incentive stock options (ISOs) and non-qualified stock options (NQSOs, or NSOs).

· Incentive stock options (ISOs).  It is an option wherein the taxation is postponed by the employee until the shares purchased with the option are sold.  There is no tax deduction to be received by the company.

· Nonqualified stock option (NQSOs, or NSOs).  This option obliges the employee to pay income tax on the spread between the amount paid for the option and the price of the stock.  A tax deduction on the spread will be received by the company. 

Stock option program for employees is practically authorized by the board of directors of the company and approved by the shareholders. The company is given the discretion to award the stock options to employees a particular percentage of the company’s shares. Through the options, the employees are given the right to buy a certain number of the company’s shares at a definite price for a particular period of time, normally 10 years.

The price, which is called “strike price,” is normally the market price of the stock on the said date when the options are given.  Usually after one year, options start vesting and fully vest after four years.  The options will be cancelled if the employee leaves the company before his or her options vest.

If the option is vested, then the employee will be able to buy from the company the given number of shares at the strike price.  He will come to a decision either to hold the stock or put up for sale in the open market.  The employee’s gain in the value of the shares is actually the difference between the strike price and the market price when the option is exercised.

The option is practically nothing or “underwater” if the strike price of the option exceeds the stock’s market price.  The option has worth, once the market price of the stock surpasses the strike price of the vested option.  The company should release a new share of stock, which can be traded publicly as the employee exercises an option.

After knowing how stock options work, you are now ready to use stock options as an influential tool of investment.  However, as a beginner you should take some precautions so as to avoid frustrations later on.  Remember, stock options are somehow complicated and if you are not careful, you will lose somewhat quickly your money.