Stock Options

Stock options are financial instruments that give the receiver a right, but not an obligation, to buy or sell stock at a certain price.

Stock options are financial instruments that give the receiver a right, but not an obligation, to buy or sell stock at a certain price. These stock option prices are often set at a lower than market value, to attract interest from investors or offer incentives to work harder in the company. Once these options are exercised, the party may buy or sell the stock in the company.

The trading volume of stock options has significantly increased in recent years . In 2022, the total U.S. options volume was 10.32 billion contracts, representing a 4.6% increase from 2021. The volume includes 9.6 billion equity-linked options, 721.2 million non-equity options, and 55.1 million options on futures.

There has been a consistent and significant increase in the trading volume of stock options over the years. This reflects the growing popularity and activity of the options market. In this article, we will discuss types, benefits, and disadvantages together with the implications of stock options.

What are Stock Options?

A stock option gives the holder the right to buy a specific number of shares at a predetermined price. You gain the privilege of providing opportunities over a limited period, known as the vesting period. Once your options vest, you have technically earned them, but you still need to buy to use them.

A simple example of a stock option would be a call option for an employee to purchase 100 shares of a company at a strike price of $2. When the market value of the shares is over $2 (either on a stock exchange for public companies, or through valuation reports for private companies), it would be beneficial for the employee to exercise their options. When the share price reaches $3, the employee can then exercise their options for $200, and then sell their shares for $300, making a $100 profit.

Let’s understand stock options more with the help of another example:

  • Company: Snooze
  • Stock Symbol: SNZ
  • Current Stock Price: $100 per share
  • Strike Price: $90 per share
  • Expiration Date: January 1, 2025

This stock option gives the holder the right to buy 100 shares of SNZ stock at $90 per share at any time before January 1, 2025. If the stock price rises above $90 per share, the holder can exercise the option and buy the shares at a discount, making a profit. However, if the stock price falls below $90 per share, the option will expire worthless.

Why do Companies provide Stock Options?

If your employer grants you stock options, they will provide a written offer letter outlining the details. To accept the grant, you must sign this agreement.

Companies commonly motivate their employees to stay longer by offering stock options. The reason behind this is that it costs money for companies to hire and train new staff, so they prefer to retain existing employees.

Stock options usually vest over several years and tend to increase in value over time because stock prices generally rise in the long term. This incentivizes employees to remain with the company and wait for the stock options to mature, which can result in additional earnings.

How do stock Options work?

Companies often use stock options as a way to entice potential employees to join their team and as a means to keep current employees. The possibility of owning company stock at a discounted rate is a powerful incentive for prospective employees.

When you exercise your options, you usually have multiple ways to do so:

  • You can exercise the options by paying the strike price in cash.
  • Employers may allow cashless exercise of options by selling some to cover costs.
  • Some employers offer a cashless exercise and sale option, allowing you to sell your options at the current market price without upfront cash or exposure to stock price volatility.

The basic components of a stock option

  • Option type -The type of option, either a call (buy) or put (sell) option.
  • Strike Price – The set price for buying or selling the asset (shares)
  • Expiration date – The date on which the rights to exercise the options expires.
  • Vesting period – If applicable, the time period in which the stock options rights are available.
  • Option premium – The cost associated with buying or selling the option.

Types Of Stock Options

A stock option is a legally binding agreement between two parties that gives the buyer the right, but not the obligation, to buy or sell a specific stock at a particular price within a specific time frame. It gives the buyer the right to buy or sell underlying stocks at a predetermined price within a specified period. The seller of the stock option is called an option writer. The buyer pays a premium to the seller for the contract.

There are two types of Stock option: Incentive stock options (ISOs) and non-qualified stock options (NSOs).

Incentive stock options

ISO, also called incentive stock option, is a kind of employee option with some added tax benefits. When an ISO is exercised, there is an option to treat any gain on this sale is taxed at the capital gains rate, rather than the standard ordinary income rate for the option holder. ISOs are usually offered to employees for a longer period of time, where these employees would contribute to the further development and growth of the company.

According to a 2022 survey by the National Association of Stock Plan Professionals (NASPP), the median number of ISO options granted to employees in 2021 was 15,000. The median exercise price for ISO options was $10 per share.

Non-qualified stock options (NSOs)

Non-qualified stock options offer workers, whether independent contractors or regular employees, the right to obtain a certain amount of the company shares for a set price. Employers tend to offer NSOs as an alternative type of compensation for the company’s best interests. NSOs are great for companies, as they minimize cash compensation an employee would earn during their employment.

Non-qualified stock options are advantageous for employers, they serve as a handy compensation method to reduce excessive cash flow, letting companies retain more liquidity and cash for fulfilling other needs. The NASPP survey also found that the median number of NSOs granted to employees in 2021 was 10,000. The median exercise price for NSOs was $15 per share.

Tax Implications of Stock Options

If you want to minimize the amount of taxes you pay on your stock options, consider exercising them when your household income and tax bracket are lower. For instance, if your spouse is between jobs, it might be a good time to exercise your options. Additionally, holding onto the stock for at least a year after you purchase it before selling can also help to reduce your taxes.

The gains from selling company stock can increase your tax liability. By planning your projected income and deductions in the future, you can choose the right time to exercise your stock options.

The tax implications depend on the option type and when it’s exercised.

Incentive stock optionsNon-qualified stock options
When an option is granted or exercised, no income is reported.When you exercise non-qualified stock options (NSOs), any gains you make are considered ordinary income.
Taxes are taxed based on the stock's holding period when it is sold, with short-term and long-term capital tax rates applying to the gains.The difference between exercise and stock prices at exercise is taxable.
The stock gain is taxed as ordinary income if held for less than a year.When you sell a stock, the time you hold it determines whether you pay short- or long-term capital gains tax.

The taxation of gains from non-qualified stock options is generally treated as capital gains. However, gains from incentive stock options can be classified as ordinary income or capital gains, depending on the holding period and other factors.

Consulting with a tax professional is crucial to understand tax implications for your situation, as tax laws may vary.

Pros and Cons of Stock Options

Giving staff stock options and deciding whether to accept them can be more complicated than they seem. This offers advantages and disadvantages for employees and employers. Employees benefit from significant return on investment, tax benefits, and ownership. Employers benefit from aligning employees with missions, improving retention, and incentivizing work.

Pros and Cons of Stock Options

Here are some thoughts on when to obtain stock options, what to avoid, and how to benefit:

Pros of Stock Options

  • Employees can become more engaged with the company, leading to increased motivation and reduced turnover.
  • Offering stock options as a company benefit can be a cost-effective way to make employment packages more appealing. It is a great way for companies to attract and retain talented employees.
  • Employees can convert potential compensation into capital gains for tax benefits.

Cons Of Stock Options

  • Stock options can be a complex matter when it comes to taxation for employees.
  • Shareholders may face significant costs in the long run due to dilution.
  • Executives may sometimes make risky decisions to increase the stock price and earn more through option compensation.

Looking for the best software to manage stock options for your company?

Offering stock options means that you will also have to keep track and manage them well. That is where stock option plan administration software for startups comes in. They are created to help you track and manage all the options in the company.

The software comes with four main factors including accuracy, efficiency, security, and comprehensiveness. In addition to this, Eqvista’s software allows you to create vesting schedules and issue shares, while the application would handle all the complex calculations of how many shares are vested and when.

If you are still not sure regarding what options are and want to know more, Eqvista can help you. Eqvista also offers a cap table application that can keep you on top of all dealings and up to date. Eqvista can help you in issuing stock options and managing them easily using vesting plans. Learn more about it here and how to use the app here. Check out and begin using Eqvista, which is the best stock option management software out there!

Interested in issuing & managing shares?

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