Types of Stock Options
Stock options are among the many types of benefits frequently offered to employees. While stock options used to be reserved for employees at the executive level, they are now available to workers at all levels of a company. While the conventional wisdom states that it is wise to hold on to stock options as long as possible, there may be compelling reasons for an employee to do otherwise. One common reason for employees to divest themselves of stock options is when they lose faith in the value of the company's stock.
Other People Are Reading
-
Stock Options Defined
-
An employee stock option is the right granted by an employer to buy, or "exercise" a given number of shares of company stock at a predetermined price, which is known as the "grant," "share," or "exercise" price. The option is open over a set period of time, known as the "exercise period." The "strike" price is usually the market value of the shares at the time the option is offered, but this is not always true. The profit for employees is realized if they can sell the stock for more than they paid during the "exercise" period.
Non-qualified Stock Options
-
For broad-based plans, non-qualified stock options are usually the choice available. With non-qualified stock options, the employee owes no tax when the option is granted. Tax liabilities only occur on the difference, or "spread," between the grant price and the stock's market value when the shares are purchased, or "exercised." If the stock is held for less than a year, the spread is taxed as ordinary income. If it is held for a year or longer, the spread is taxed at the rate of capital gains, which is generally lower. Companies deduct the spread as a compensation expense.
-
Qualified Stock Options
-
Qualified stock options are also known as incentive stock options. With qualified, or incentive, stock options, no taxes are charged during the "grant" or the "exercise" period. Taxes are deferred until the stock is sold, and taxes are imposed at the rate for capital gains, provided the stock is sold at least two years after the "grant" period and at least one year after the option is "exercised." If the stock is sold before the required period for tax deferment, the sale is called a "disqualifying disposition" and taxes are imposed at the higher individual tax rate. Qualified stock options are usually reserved for top-level employees because companies receive no tax benefits from them.
Exercising the Option
-
There are three ways of "exercising" a stock option. The most common way is to pay cash for the stocks. A second means is called a "stock swap" which allows employees to trade stocks in the company they may already own to pay for the "exercise" of the option. The third option is called a "cashless exercise" where employees borrow the money to buy the stock from a stockbroker and simultaneously sell enough other stock they own to cover the price of the "exercise" plus any transaction fees.
Considerations
-
When the market is volatile, a company may change the price of the option to reflect the present state of the market. This is done by canceling the original option and offering a new option to employees, usually at a lower price. Outside investors are not eligible for this, however. Non-qualified options are transferable to children and even to charities. Qualified stock options may not be transferred. Additionally, no more than $100,000 in qualified stock options may be "exercised" in a single year.
-
