Leveraged & Non-Leveraged Stock Options
In an Employee Stock Option Plan, or ESOP, employers offer employees the option to purchase corporate stock in the future. When an employer or employee makes ESOP contributions, the company holds them in an Employee Stock Option Trust, or ESOT. The two basic types of stock options employers offer are leveraged and non-leveraged.
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Stock Options Agreements
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A stock option agreement is a contract between the employee and the employer. These agreements vary by employer but often include the number of shares the employee has the option to purchase, purchase date, strike price and vesting schedule. The strike price is the price at which employees can buy the stock. A vesting schedule sets how long employees must wait before they receive full ownership of their shares.
Leveraged
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With leveraged options, the ESOT takes out a loan to purchase stock from the company or existing stockholders. The company sponsors or guarantees the loan on the ESOT's behalf. The company makes annual tax-deductible cash or stock contributions to the ESOT. These annual cash and stock contributions allow the ESOT to pay back its loan. When the accounts for ESOP participating employees fully vest, the employees can exercise their options for cash or additional stock.
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Non-Leveraged
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With non-leveraged options, the company contributes stock or cash to the ESOT annually. If the contribution is stock, the ESOT distributes the contribution among participating employees. The amount it distributes into each participating employee account depends on the company's ESOP allocation formula. ESOP allocation formulas can vary by company. If the company contributes cash, the ESOT uses the contribution to purchase stock from the company or existing shareholders. In both cases, the ESOT holds the stock on behalf of participating employees until their accounts fully vest.
Exercising Options
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When the vesting period ends, the ESOT no longer retains control of the options and fully vested employees can decide to hold, sell or trade their shares. If they sell their options for a profit, meaning the current stock price is higher than the strike price stated in their options contract, this can trigger capital gains taxes. If the current stock price is less than the strike price, it results in capital losses.
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