Screening should go both ways. The broker you choose to trade options with is your most important investing partner. Finding the broker that offers the tools, research, guidance and support you need is especially important for investors who are new to options trading. Get trusted investing insights. As a refresher, a call option is a contract that gives you the right, but not the obligation, to buy a stock at a predetermined price called the strike price within a certain time period.
A put option gives you the right, but not the obligation, to sell shares at a stated price before the contract expires.
What Should You Do with Stock Options When Leaving a Job?
Depending on which direction you expect the underlying stock to move determines what type of options contract to take on:. If you think the stock price will move up: buy a call option, sell a put option. If you think the stock price will stay stable: sell a call option or sell a put option. If you think the stock price will go down: buy a put option, sell a call option. If the stock does indeed rise above the strike price, your option is in the money.
If the stock drops below the strike price, your option is in the money. Option quotes, technically called an option chain or matrix, contain a range of available strike prices. The price you pay for an option, called the premium, has two components: intrinsic value and time value. Intrinsic value is the difference between the strike price and the share price, if the stock price is above the strike.
Time value is whatever is left, and factors in how volatile the stock is, the time to expiration and interest rates, among other elements. This leads us to the final choice you need to make before buying an options contract. Every options contract has an expiration period that indicates the last day you can exercise the option. Your choices are limited to the ones offered when you call up an option chain. There are two styles of options, American and European, which differ depending on when the options contract can be exercised. Holders of an American option can exercise at any point up to the expiry date whereas holders of European options can only exercise on the day of expiry.
Since American options offer more flexibility for the option buyer and more risk for the option seller , they usually cost more than their European counterparts. Expiration dates can range from days to months to years. Daily and weekly options tend to be the riskiest and are reserved for seasoned option traders. For long-term investors, monthly and yearly expiration dates are preferable. Longer expirations give the stock more time to move and time for your investment thesis to play out.
As such, the longer the expiration period, the more expensive the option. A longer expiration is also useful because the option can retain time value, even if the stock trades below the strike price. If a trade has gone against them, they can usually still sell any time value remaining on the option — and this is more likely if the option contract is longer. Many or all of the products featured here are from our partners who compensate us.
This may influence which products we write about and where and how the product appears on a page. However, this does not influence our evaluations. Our opinions are our own. Rather than granting shares of stock directly, the company gives derivative options on the stock instead.
Terms of ESOs will be fully spelled out for an employee in an employee stock options agreement. The benefit of ESOs for early employees is quite simple.
By choosing to work for a startup an employee is taking an inherent risk. To get compensated for the risk employees are offered ESOs. On the flip side, startups are also incentivized to offer employee stock options. Ultimately, employee stock options are an instrumental part of finding and retaining top talent for startups.
While strapped for cash, startups often cannot compete with salary offers from larger firms so can attract top talent by offering equity and ownership in the company. Similar but not to be confused with employee stock option plans are employee stock ownership plans. The plan maintains an account for each employee participating in the plan. Shares of stock vest over time before an employee is entitled to them. With an ESOP, you never buy or hold the stock directly while still employed with the company.
The key difference between an employee stock ownership plan and employee stock option is that an ESOP is a retirement plan. Whereas an ESO is when an employee has the right to buy shares at a set price over a given period of time. Employee stock options come in two main types of options: incentive stock options and non-qualified stock options. The main difference between the two mostly revolves around their tax structure. The profit on incentive stock options is taxed at the capital gains rate, not the higher rate for ordinary income. To get started, there are a few tax benefits when it comes to ISO.
The first benefit comes when exercising AKA buying your shares. Generally speaking, you do not have to pay taxes when buying incentive stock options. Assuming you exercise your shares and hold on to them for at least one year, you qualify for a tax benefit on the selling end as well. As Investopedia mentions above, when selling your ISO shares you are potentially taxed at capital gains as opposed to ordinary income. Generally speaking capital gains taxes are less than ordinary income taxes.
However, if you sell your shares immediately after exercising you will be taxes at the ordinary income level similar to Non-qualified stock options. ISOs are generally awarded to high level managers and high value employees. For a startup, this usually means the early employees and founders. On the opposite end of incentive stock options are non-qualified stock options.
As we mentioned earlier, it comes down to the tax benefits. Whereas incentive stock options are only taxed when selling and potentially taxed at the capital gains rate , non-qualified stock options are taxed when exercising and selling your shares. Non-qualified stock options are more common than incentive stock options. It is important for both startup founders and early employees it is important to understand how employee stock options work.
The different tax structures, terminology, and legal documents can make it an intimidating task. As stock options are an integral part of startup culture there are a few terms and ideas that everyone should be familiar discussing.
Generally when signing a job offer you will receive an offer grant. It is important to remember that stock options are not actual shares of stock but rather the option to buy these shares at a set price on a later date.
Exercise Stock Options: Everything You Need to Know
So how do you make money on stock options? When the price between the offer or grant price the price you can buy the shares at and the market value of the company rises. At the time of receiving an offer letter you will also receive a stock option agreement. This document will include different dates, terms, and details that are pertinent to your grant. This includes what type of options you will receive, number of shares, vesting schedule, and the expiration date.
Vesting is a mechanism that companies can use to encourage employees to stay longer. As we mentioned earlier when you receive a stock option this is not actual shares but rather the ability to buy shares at a later date. In order to retain employees, most companies will include a vesting schedule with their offer. This is the schedule in which you will have the ability to exercise your shares. A vesting schedule usually takes place over a period of time and may be split over the course of a few years or milestones.
The most common vesting schedule for startups is a time-based schedule. The most common startup setup is a 4 year vesting schedule with a 1 year cliff. This means that after working for a company for a full year, the employee will receive the first quarter of their shares 1 year cliff. After the first year, the employee will receive their remaining shares over the next 3 years on a specific calendar.
There are clear pros and cons of employee stock options. Generally speaking the benefits of ESOs outweigh the cons. From the perspective of a startup, the benefits of ESOs are quite clear. Generally speaking startups are strapped for cash and may not be able to compete with larger firms hiring for the same positions.
When top talent is evaluating where to work they are generally looking for a few things: ownership, collaboration, transparency, and growth. Ownership can come in 2 forms, ownership in their work and ownership in the company. Offering ownership in the form of stock options is a surefire way for a startup to find and retain top talent. At the end of the day, early startup employees are taking a risk and likely a paycut to join a team that is attacking an interesting market or building a strong product.
Rewarding talent for taking the risk is a must for early stage startups.
What is a stock option?
As we alluded to above, the pros of offering employee stock options are quite clear for a startup. On top of the ability they can be used as a tool to attract and retain top talent there are a few other pros:. However, with pros comes cons. While not as plentiful as the pros of offering employee stock options there still are cons of offering ESOs. As we mentioned above, there are still cons when it comes to startups offering employee stock options. A few common cons startups often see with employee stock options are:. While the pros generally outweigh the cons of offering employee stock options.
There still are cons that startups and founders need to work through when it comes to offering stock options as a form of employee compensation at their company.