Unfortunately, stock options terminology can sound overwhelming to students or new entrepreneurs. There’s plenty of jargon to make things seem unclear, but the truth is that the principles behind stock options are fairly straightforward.
So today, we’re going to answer some questions to simplify things for you.
What Are Stock Options?
A stock option is a contract that gives the holder (an employee of a company) the right but not the obligation to buy or sell a specified number of shares of stock at a specified price within a specified time. Simply put, stock options allow you to buy a stake in a company at a reduced price, and if the value of a stock goes up, you can make a huge amount of money.
What Is the Market Rate for My Position?
The rate of compensation you can expect to earn as a stockbroker depends on the specific role and company you choose to work with, as well as your experience and other credentials. Working at a bank or other financial institution can offer a very competitive base salary, along with earnings potential from commissions and bonuses.
What Factors Determine the Price of an Option?
The price of an option directly correlates with the perceived risk of the trade. Put options, which give their owner the right to sell a stock at a predetermined price for a certain amount of time, are always more expensive than call options. This gives their owner the right to buy a stock at a predetermined price for a certain amount of time. This is because investors perceive put options as being riskier than call options.
What Is the Vesting Schedule?
The vesting schedule is a set of rules that govern how options are granted and become 100% vested. In the US, the SEC sets a vesting schedule to encourage employees to remain committed to their jobs for a specified period of time. The amount of time that an employee has to wait before the options become vested depends on the company. Some companies have their own set vesting periods, while others follow a vesting schedule built into various plan documents.
What Taxes Do You Have To Pay When Exercising a Stock Option?
If a company like SoFi Invest grants stock options to you as an employee, the company should include an estimate of how much you should pay if you choose to exercise those options. The IRS has a helpful page that details capital gains taxes for employees exercising stock options.
What Are the Pros and Cons of Stock Options?
There are several types of employee stock purchase plans, but consider the following advantages when weighing your options.
- Employee motivation — employees have an incentive to work harder and create more value
- Encourages retention — if employees have stock options, they’re more likely to stay with the company for the long-term
- You can use it in lieu of a salary — if a company doesn’t have a lot of cash, they can give the employee a smaller salary and compensate with stock options
The benefits of stock options are well known, but what are the drawbacks?
- They don’t vest until the employee meets the requirements (e.g., time and performance-based vesting)
- It’s harder for startups to offer stock options because they are less valuable than public companies
- If the employee leaves before the options are fully vested, they can be forfeited
- Stock options are only valuable if the company is successful, so there are high risks involved
There are many benefits to stock-based compensation, and there are downsides as well. It can be a powerful incentive tool to attract employees, but a poorly executed plan can be a big drain on a company’s earnings. Thanks for reading.