Employee Stock Options Explained

These days most companies offer some form of employee benefits. Among the most common are insurance plans (health/dental/vision), and if you’re lucky, a savings plan for retirement. 

The problem is, although these plans are a great way to recruit and retain top talent, very few employees have a complete understanding of the benefits that their companies offer.

This is especially true if you’re fortunate enough to work for a company that provides employee stock options as a benefit.

Employee stock options are one of those things that you’ve probably heard about in passing, but never really understood what they were or how you could use them to your advantage.

Although the particulars vary from company to company, the basic idea behind the benefit is to provide workers with the opportunity to buy discounted company stock which they can then sell at a future date.

But before we get too far ahead of ourselves, let’s take a closer look at what employee stock options are, the benefits to both you and the company, and most importantly -- what you can do with them.

What are employee stock options?

When a company offers stock options to its employees, it is giving them an opportunity to purchase a pre-determined number of shares of the company’s stock at a fixed price, within a set time period.

This can present a great buying opportunity for employees if the fixed price is lower than the current market price -- and certain requirements are met.

Typically, in order to take advantage of this benefit you must continue to work at the company for a specified length of time before you are allowed to exercise any of the stock options. That length of time is called the vesting period and carries with it what’s known as a vesting schedule.

A vesting schedule states when the employee is able to exercise the options -- whether that is all at once (cliff vesting) or over time (graded vesting).

Here’s an example:

Let’s say you were granted 500 stock options when your company's stock price was $15 per share.

Your exercise price (the fixed price that you would pay for stock) is $15.

• Under the vesting schedule, 25% of the options vest per year over four years (ex: 125 options per year).
• After four years, all of the options have become exercisable.
• By this time, the company's stock price has risen to $25.
• The options give you the right to buy 500 shares of the company's stock at your exercise price of $15 per share rather than at the market price of $25 per share.
• If exercised, you will have paid $7,500 for stock that could then be sold in the market for $12,500.

What’s in it for the Companies?

Companies decide to offer stock options as an employee benefit for a number of reasons.

For starters, no matter what industry you’re in, there will always be competition. That’s why many companies use stock options as a way to entice new and retain existing employees. This is especially beneficial if their competitors don’t have employee stock option plans in place.

Additionally, by offering employees the option to purchase stock it enables them to feel less like a worker and more like a business partner. From a business perspective, this results in improved on-the-job performance from employees who own stock and stock options.

But the company isn’t the only one that benefits...

What’s in it for the Employee?

If your company offers a stock option plan, one of the primary benefits that you will recognize is the price. While the company establishes the exercise price of the stock option offering, the idea is that the share price will eventually increase and allow you to sell the stock sometime in the future at a higher price, yielding a profit.

There is, however, a downside.

As is always the case with owning stock, there’s the possibility that some stocks just won’t perform well -- and owning stock options are no different.

In situations like these, if the market value of the stock drops lower than the exercise price, there’s a chance that you might be left with worthless stock options.

What can be done with company stock options?

Employees with stock options have various ways to utilize their benefits. Here are a few of the possibilities:

• Convert and Sell – Exercise options to purchase the discounted shares and then sell it all.
• Sell Some and Keep Some – Exercise option to purchase the discounted shares and sell some of the stock immediately but keep the remaining stock to sell at a later date should the price rise in the future.
• Hold them to Sell Later – Exercise option to purchase the stock and hold on to it and monitor market value with the intent to sell in the future if and when market value has increased.

Next steps

While company stock options may present an excellent buying opportunity, remember that they are just a piece of your overall financial picture.

There’s a lot to learn about stock options and this post just scratches the surface. Even if you wanted to understand every detail you’re looking at hours upon hours of research and even then, one error could result in thousands of dollars in extra taxes.

The good news is, you don’t have to know everything there is to know, you just need to know the right place to look.

If you have questions about stock options that are beyond the scope of this post, don’t hesitate to reach out. We’d love to help!

View Disclosures Here