Employee stock options explained

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Perhaps you have been offered employee stock options as part of your employment package, and you are not to familiar with what they are all about. Hopefully this article will be able to help.

What are employee stock options?

Employee stock options are a contract that is offered by the company to its employees to purchase a capped number of stocks at a fixed price during a certain period of time.  Just like all option contracts, there is no obligation for the owner of the option contract to purchase the respective assets.

Therefore upon being offered employee options you have the right to choose whether or not to enforce the option contract.  The terms of the employee option are stated within in the contract and they determine the nature of how and when you can enforce the options.

Understanding the terms of the employee contract 

Here is a condensed summary of the terms that you will find on your options contract: 

  • Grant price/exercise price/strike price â€“ the specified price at which your employee stock option plan says you can purchase the stock
  • Issue date â€“ the date the option is given to you
  • Market price â€“ the current price of the stock
  • Vesting date – the date you can exercise your options according to the terms of your employee stock option plan
  • Exercise date â€“ the date you  exercise your options
  • Expiration date â€“ the date by which you must exercise your options or they will expire

The terminology definitions have been sourced from : https://www.thebalance.com/understanding-your-employee-stock-options-2388513

In an option contract the most important things that you need to identify are as follows

  • The asset , it is very important that you know which assets this option contract is referring to. Usually it is an offer of stocks in the company.
  • The grant price 
  • The expiration date

The benefit of employee options:

The biggest benefit of employee options is that if the company offers you the company stocks at a fixed price. Therefore if the price of the company stocks increases then you are able to profit from the investment made in terms of the contract.

The risk

The risk is that you may execute your right in terms of your price options and the value of the stocks in that company decrease, or on the more extreme end if it is a startup the  company may never go public and therefore there will be less or no value for those stocks. Also the other risk may be that you will have too much exposure in one company, that can result in a lot of financial risk. For example if the company becomes bankrupt and it is your primary place of work , you now have lost your primary source of income as well as your investments in their stocks through the option contract.

Therefore it is highly advisable that you do your due diligence and asses your company as a viable vehicle for investment , before exercising your option right.

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