How Stock Options Work

Stock options are a common form of compensation offered by companies to their employees, especially at startup companies. Stock options give employees the right to purchase a certain number of shares of the company's stock at a predetermined price, known as the exercise price or strike price. Stock options can be a valuable benefit for employees, as they can provide the opportunity to share in the company's success and potentially earn a significant return on their investment.

There are two main types of stock options: incentive stock options (ISOs) and non-qualified stock options (NSOs). ISOs are only available to employees and offer certain tax benefits, such as the ability to defer tax on any profit until the shares are sold. NSOs, on the other hand, are available to both employees and non-employees and do not offer the same tax benefits as ISOs.

When an employee is granted stock options, they are usually vesting over a set period of time, known as the vesting period. This means that the employee must remain with the company for a certain number of years in order to fully vest their stock options and be eligible to exercise them. For example, if an employee is granted 100 stock options with a four-year vesting period, they will vest 25 options per year for four years, provided they remain with the company.

Once the stock options vest and the employee is eligible to exercise them, they can choose to do so by paying the exercise price and purchasing the shares of stock. The employee can then hold onto the shares and potentially sell them at a later date for a profit, if the value of the shares has increased. It's important to note that stock options are not the same as company stock and do not provide the same level of ownership or control. Stock options are simply the right to purchase stock at a certain price, and the value of the options is dependent on the value of the underlying stock.

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