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How Stock Options Work
Nowadays companies are giving more and more important to stock options. They are not just offering stock options to top-rung executives but also to employees lower down in the hierarchy. The question is why are companies going out of their way to offer stock options to employees and why are the employees taking stock options? |
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Before we see how stock options work, we look into what are stock options. Stock options give you the right to buy precise number of shares of your company at a price and time stipulated by your company.
Usually companies give out stock options to employees in order to attract and retain good workers. The idea behind stock options is to ensure that employees feel a sense of ownership. The price that the company sets on the stock is discounted and the market price is taken into consideration at the time of giving an employee stock options. This is done with the belief that the price of the shares will go up so that when they are sold, the shares will yield a profit.
Stock options are a way of providing potential cash to employees which is over and above the salary they receive.
Let us assume that your company gives you the option to buy 100 shares at $5 a share. This happens on a particular date. You are allowed to exercise your option a year later and when the time comes, each share is now worth $10. Now you have three choices in front of you.
- You can convert your options into stock and purchase each share for $5 and then sell them after waiting for a particular period of time as specified in your agreement with your company.
- You can sell just some shares after the mandatory waiting period and retain some. However, before that you would have to buy your 100 shares at $5 a share.
- You can buy the 100 shares and hold on to them till the price per share increases even further.
Each company stipulates a vesting period. You can either buy all your stocks at one go or spread out the vesting over a period of time. Usually a company would spread out the vesting period over a few years and employees can buy just so many shares based on an agreed schedule.
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