Stock Options Explainer
An employee stock option gives the holder the right, but not the obligation, to buy company shares at a fixed exercise price before expiration. Options commonly vest over time or after performance conditions. Until exercised, the employee usually does not own the underlying shares or receive shareholder rights.
An option has intrinsic value when the share value exceeds the exercise price, and it can also have time value before expiration. If the share value remains below the exercise price, the option may expire worthless. Private-company employees also face uncertain valuation and limited ability to sell shares.
U.S. tax treatment differs between statutory incentive stock options and nonstatutory options, and consequences can arise at grant, exercise, sale, or an alternative minimum tax calculation. Rules vary by person and jurisdiction, so employees need current professional tax advice before exercising or selling.
For companies, option grants create compensation expense and potential dilution. For employees, exercising may require cash and create a concentrated position tied to the same employer that provides income. Evaluate vesting, expiration, post-termination deadlines, taxes, exercise cost, liquidity, and portfolio risk together.
The exercise price and expiration date define the option contract.
Vesting controls when the right becomes usable.
Options can gain substantially or expire without value.
Private-company shares may be difficult to value or sell.
Cash, taxes, concentration, and liquidity affect the decision.
Tax treatment depends on option type and individual facts.
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