Does your company offer you stock options.
Or are you just confused by what they are. Well, a stock option is a financial
instrument that gives you the right, but not the obligation, to purchase a
given stock at an agreed-upon price and date.
While we can get into a lengthy explanation of the differences between
Put Options and Call Options, today we want to look at what your employer is
offering you. Employee Stock Options
(ESOs). These are a type of compensation
that your employer will issue you (works like a Call Option), that are not
traded in the stock market, and are restricted to just stock of a company given
to their employees.
There are 2 main types of ESOs.
Incentive Options and Non-qualified Options. Let's look at each.
- NQO's ( Non-Qualified Stock Options)
A non-qualified stock option is one methodology for a company to compensate
key employees or others in an organization without having to actually pay them
cash. They work best for employees within a company that has a
rising stock price.
The company will grant the employee an option to purchase shares of stock at
a fixed price. For example, Coke grants an employee 1,000 options at $65
which are good for 10 years. This means that the employee has the
right over the next year no matter how high the stock prices goes to purchase
1,000 shares of Coke stock at $65. So, if Coke's stock goes to $95,
then the option is worth $30 per share or $30,000 to the employee if
exercised. All of these types of options will be taxed at ordinary
income rates, which is a consideration that needs to be made at the time of
exercising the option. When the stock isn't publicly traded, the company
determines the value of a share of stock on the date the option is granted. The
options typically lapse on a certain date which is predominately 10 years from
the grant date.
- ISO's (Incentive Stock Options)
An incentive stock option (ISO) is a corporate benefit that gives an
employee the right to buy shares of company stock at a discounted price with
the added benefit of possible tax breaks on the profit. The profit on qualified
ISOs is usually taxed at the capital gains
rate, not the higher rate for ordinary income. Stock options are issued, or
"granted," at a price set by the employer company, called the "strike price."
ISOs are issued on a beginning date, known as the grant date, and then the
employee exercises
their right to buy the options on the exercise date. Once the
options are exercised, the employee has the freedom to either sell the stock or
keep it.
Important: ISOs must be held for more than one year from the date of
exercise and two years from the time of the grant to qualify for more favorable
tax treatment.
For the employee, the downside of the ISO is the greater risk created by the
waiting period before the options can be sold.
While not a Stock Option, since we are talking about employee stock, I thought I'd throw in Stock Purchase plans.
ESPP's (Employee Stock Purchase Plan)
An employee stock purchase plan (ESPP) is a company-run program in which
participating employees can purchase company stock at a discounted price. Usually the discount is between 5 and 15%. Once purchased, there are no
restrictions. You own the stock and can
do whatever you want with it.
If you would like to receive more information on making smart money moves for your future, be sure to contact us today!
