Explanation of Stock Options
Stock options are oftentimes offered as part of an employee benefits package by cash-strapped companies to incentivize employees when they can't afford to pay higher salaries or cash bonuses.
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Definition
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Over 9 million employees participate in over 3,000 stock option plans. A stock option is an agreement that an employee will be allowed to purchase his employer's stock at a set price at a specific time in the future.
Types
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Stock you purchased through exercising your stock options can be taxed. Incentive stock options, commonly called ISOs, permit the employee to defer taxation on the shares purchased until she sells the stock. Non-qualified stock options, or NSOs, require the employee to pay tax on the "spread" (difference) between the grant price and the market value of the stock at the expiration date.
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Function
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Counting on stock options paying off is a gamble. If the grant price of the stock is less than the market value of a stock at the expiration date, the employee gets to buy the number of shares in his option at a bargain price. If the grant price is greater than market value at the expiration date, the stock options are worthless.
Exercising
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The employee can simply pay cash and buy the stock; she can swap it for stock she already owns; or she can pay for the stock by simultaneously selling enough of the stock to cover the exercise price through a bridge loan from her stockbroker.
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References
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