Options Trading Tutorial

When a company issues stock options to an employee, how does that work?

How does the employee benefit, or not? How does the pricing work? Does it involve issuing new stock?

Public Comments

1. magic.
2. The option is based on a specific time period for the strike price. Usually it is 30,90 12 months of employment. You have the right but not the obligation to exercise the option. It benefits you because if the option strike price is $30.00 a share and you have 100 shares and the price goes up to $40.00 a share you would have equity of $1,000.00. Normally it is a good benefit because it is theoretically tied to the perfomance of the company. The more productive the employees are then the more likely the stock share will go up. It is a way of rewarding employees for their productivity. This type of compensation was common among hi-tech companies in the late 90's but accounting changes were made which made it less beneficial for companies to offer stock options. Your Human Resource department should be able to give you more information about your potential options. The downfall is that it is variable. The price can go below the strike price and would make the option out of the money. Meaning the option would be worthless. Compare this with having a set bonus every year and I think the drawbacks are obvious. I hope this helps you. Good Luck
3. The employee benefits because they hold a peice of paper that says they can buy stock for a predetermined price (aka "option" price, strike price). At some time in the future (after a "vesting" period) they can "excersize" that option - meaning that no matter what the market value is, they can buy the stock for the strike price they are holding. If the market value is higher than the strike price, then the employee buy stock at the (lower) strike price and immediately sell it at the market price and put the difference in their pocket. If the market value is lower than the strike price, the employee is holding an "underwater" option - and they get nothing. Stock options are usually priced at market value on the day they are granted. Some companies give executives specially priced options to insure they are "in the money". There are accounting complexities to this though. Options are a promise to give stock out at a future date, so yes, the company giving them has to have stock held back in reserve. This is called "overhang", and it can be a bad thing.
4. the idea of options have been covered above, so I will tell you a little about some technical and tax issues you need to consider. options that are issued when you join the company are usually call ISO (insentive stock option) and these have special tax consequenses. When you exersise them and hold them for a period of time, they are treated as long term capital gain but the year you exercise them, you may be subjected to AMT(a special tax originally designed to tax the very rich who got away without paying any tax). there are many things that can trigger AMT. If you exercise and sell on the same day, they are treated as ordinary income. Generally taxes are not withheld on these, so you must set aside enough when taxes are due. The second kind of option is called an non-qual (non-qualified). These are considered ordinary income. Often taxes will be withheld automatically if you do a same day exercise/sell