What is Stock Option?

Stock options are a sort of alternative pay offered by some organizations, notably many startups, as part of their employee benefits package. Employees join at a lower-than-average salary in exchange for the chance of a large payout later on. If you've been given options as part of a compensation package, make sure you understand how they function before exercising and selling them. A financial advisor could assist you in developing a financial strategy for your stock options or other investments.

Stock Options Explained

Stock options are a type of reward. Employees, contractors, consultants, and investors can all receive them. These contracts provide an employee with the right to purchase, or exercise, a certain number of shares of company stock at a certain price, commonly known as the grant price. However, this offer is only valid for a limited time. 

Before your options expire, you have a certain period of time to exercise them. Your employer may also compel you to exercise your options within a certain amount of time after you leave.

Depending on the firm, the amount of options available to its employees varies. It will also be determined by the employee's seniority and specific skills. Before any employee can get stock options, investors and other stakeholders must provide their approval.

Features of Stock Options

Mentioned below are the characteristics of Stock options:

  1. Date of Expiry

Options allow a trader to not only bet on a stock rising or falling but also to specify a specific date when the stock is expected to climb or decrease. The expiration date is what it's called. The expiration date is significant because it aids traders in determining the time value of the put and call, which is employed in various option pricing models.

  1. Strike Price

Whether or not an option should be exercised is determined by the strike price. A trader would expect the stock to be above or below this Price by the expiration date. A trader might buy a call for a specific month and strike price if they believe IBM will rise in the future.

  1. Contract Size

Contracts denote the number of underlying shares that a trader wants to purchase. One hundred shares of the underlying stock are equal to one contract.

  1. Premium

The premium - is the price paid for an option. It is calculated by multiplying the call price by the number of contracts purchased, then multiplying by 100.

How Does a Stock Option Work?

Stock options are often utilized to attract new personnel and retain the existing ones.

The probability of owning company shares at a discounted rate when compared to purchasing stocks on the open market is the inducement of stock options to the prospective investors.

Employees that have been given stock options are retained through a process known as vesting. Employers might use vesting to encourage employees to stay through the vesting term and take ownership of the options they've been given. Until you've met the vesting schedule's conditions, your options aren't actually yours.

Types of Stock Options

Stock options are divided into two categories:

  • A stock call option gives the buyer a choice to buy stock but not the obligation to do so. When the underlying stock price rises, the value of a call option rises as well.
  • A stock put option allows the buyer to sell a stock for a profit if the prices of the underlying stocks fall - the value of a put option rises.

How to Exercise Stock Options

To begin with - you can't utilize your options until they have been vested.

There could be some agreements that allow the vesting timeline to be accelerated, though these are rare. There are also time constraints on when you could exercise or access your options, which normally last 5 to 10 years after the award date. Furthermore, if you are laid off before your options are fully vested, you may lose your unvested options.

When you're ready to put your options to the test, you usually have a few possibilities:

  • You can pay cash to execute the options at the strike price if you have the funds.
  • Some employers let you exercise your options without paying any money by selling just enough of them to cover the costs of exercising others.
  • Some employers allow you to exercise and sell your options at the current market price. This means you won't be exposed to stock price volatility in the future, and you would not have to bring any cash upfront to exercise.

 

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