Off topic – stock options

[USMCBunny]

Just in case anybody has the time to spell something out for me, I know it’s off topic, but there are very smart people who post here…

My wife is moving up in the business world, and has been “granted” stock options.

“You have been granted 1100 options. The stock option grant date is 21 Sep, 2007 with an option price of $26.35″… The letter says to keep this “confidential”, thus I have not named the company yet.

Any of you really smart types that could dumb this down for me… ie: tell me how to capitalize on this, it would be very much appreciated.

Isn’t this just an opportunity to invest into one’s own company?

Thanks

[Raybyrnes]

You are granted options so they are yours. You do not have to buy them. In this case they are letting you know your option strike price 26.35. If the price of the stock goes to let’s say 27.35 and you have 1100 option then the value of the option would be $1100 dollars. If on the other hand the stock price is below the 26.35 then they are worthless for now.

For you to see if there is anything to capitalize on you need to find out what the current market price is for the securities. From there you can begin to make some decisions.

How do stock options work?

Job ads in the classifieds mention stock options more and more frequently. Companies are offering this benefit not just to top-paid executives but also to rank-and-file employees. What are stock options? Why are companies offering them? Are employees guaranteed a profit just because they have stock options? The answers to these questions will give you a much better idea about this increasingly popular movement.
Let’s start with a simple definition of stock options:

Stock options from your employer give you the right to buy a specific number of shares of your company’s stock during a time and at a price that your employer specifies.
Both privately and publicly held companies make options available for several reasons:

They want to attract and keep good workers.
They want their employees to feel like owners or partners in the business.
They want to hire skilled workers by offering compensation that goes beyond a salary. This is especially true in start-up companies that want to hold on to as much cash as possible.
The price the company sets on the stock (called the grant or strike price) is discounted and is usually the market price of the stock at the time the employee is given the options. Since those options cannot be exercised for some time, the hope is that the price of the shares will go up so that selling them later at a higher market price will yield a profit. You can see, then, that unless the company goes out of business or doesn’t perform well, offering stock options is a good way to motivate workers to accept jobs and stay on. Those stock options promise potential cash or stock in addition to salary.
Let’s look at a real world example to help you understand how this might work. Say Company X gives or grants its employees options to buy 100 shares of stock at $5 a share. The employees can exercise the options starting Aug. 1, 2001. On Aug. 1, 2001, the stock is at $10. Here are the choices for the employee:

The first thing an employee can do is convert the options to stock, buy it at $5 a share, then turn around and sell all the stock after a waiting period specified in the options’ contract. If an employee sells those 100 shares, that’s a gain of $5 a share, or $500 in profit.
Another thing an employee can do is sell some of the stock after the waiting period and keep some to sell later. Again, the employee has to buy the stock at $5 a share first.
The last choice is to change all the options to stock, buy it at the discounted price and keep it with the idea of selling it later, maybe when each share is worth $15. (Of course, there’s no way to tell if that will ever happen.)
Whatever choice an employee makes, though, the options have to be converted to stock, which brings us to another aspect of stock options: the vesting period. In the example with Company X, employees could exercise their options and buy all 100 shares at once if they wanted to. Usually, though, a company will spread out the vesting period, maybe over three or five or 10 years, and let employees buy so many shares according to a schedule. Here’s how that might work:
You get options on 100 shares of stock in your company.
The vesting schedule for your options is spread out over four years, with one-fourth vested the first year, one-fourth vested the second, one-fourth vested the third, and one-fourth vested the fourth year.
This means you can buy 25 shares at the grant or strike price the first year, then 25 shares each year after until you’re fully vested in the fourth year.
Remember that each year you can buy 25 shares of stock at a discount, then keep it or sell it at the current market value (current stock price). And each year you’re going to hope the stock price continues to rise.
Another thing to know about options is that they always have an expiration date: You can exercise your options starting on a certain date and ending on a certain date. If you don’t exercise the options within that period, you lose them. And if you are leaving a company, you can only exercise your vested options; you will lose any future vesting.

One question you might have is: How does a privately held company establish a market and grant (strike) price on each share of its stock? This might be especially interesting to know if you are or might be working for a small, privately held company that offers stock options. What the company does is to fix a price that is related to the internal value of the share, and this is established by the company’s board of directors through a vote.

Overall, you can see that stock options do have risk, and they are not always better than cash compensation if the company is not successful, but they are becoming a built-in feature in many industries.

Here are some interesting links:

Employee Stock Options Fact Sheet
The Investment FAQ
How Stocks and the Stock Market Work
Stock Links

[USMCBunny]

Thanks Raybyrnes … so this is sort of a no lose deal, if the price of the stock goes up, do we buy the stock at the reduced price and then sell them at the higher price? Seems to easy, though, that presupposes the stock will go up. Guess I should check and see.

Flywestcoast

[Raybyrnes]

I would say there is more to it than that. You probably need to find out if these are ISO (sometimes referred to as Statutory or Qualified Option) and NSO (Non Qualified Stock Options. There are a number of different strategies that you can use to maximise the value of a transactions. You can exercise and Hold, exercise and sell along with different combination of the 2.

With 2 working people and your wife moving up the corporate ladder I would pay attention to the ramifications of potentially being hit with AMT (alternative minimum tax)if you generate gains off the options. I would also evaluate the potential of the company and how much exposure you have to this sector.

WIth your wife moving up the best deal might be to find professional assistance. It is typically money well spent.

[USMCBunny]

Folks,

Thanks so much for the great (and fast) response.

The Last para in the letter states…

“This stock option grant is subject to the terms and conditions set forth in the XXX inc Amended and Restated 2006 Long Term Incentive Stock Option Plan. You should recieve your grant documents for your acceptance via the E*trade system w/in 60 days.”

So – I suppose the vesting sched, and timelines will be in there, I will fire more questions as they come.

As for the professional advice…. I agree in principle. We hired some financial planners about 1.5 years ago. They accepted a check for 1,000.00 and produced a massive folder which basically assumed I had never heard of compound interest, and then tried to sell me overpriced life insurance.

I have the basics down. Long/Medium/Short term investment plans have been successful thus far. I am considering sitting down with Rich and his associates, or some other planning outfit that I feel I can trust. My issue, is that I want more than a vanilla graph of historic investment trends … USAA told me 6 months ago to get out of gold, that it was too volitile, and that it was due for a fall. I would have lost a nice chunk had I taken that advice.

I post very rarely, but read this blog (and a couple others) pretty religiously. Is a financial planner going to do more for me?

Thanks again for the info (this particular bit, and the last couple years)

[USMCBunny]

Folks,

Thanks so much for the great (and fast) response.

The Last para in the letter states…

“This stock option grant is subject to the terms and conditions set forth in the XXX inc Amended and Restated 2006 Long Term Incentive Stock Option Plan. You should recieve your grant documents for your acceptance via the E*trade system w/in 60 days.”

So – I suppose the vesting sched, and timelines will be in there, I will fire more questions as they come.

As for the professional advice…. I agree in principle. We hired some financial planners about 1.5 years ago. They accepted a check for 1,000.00 and produced a massive folder which basically assumed I had never heard of compound interest, and then tried to sell me overpriced life insurance.

I have the basics down. Long/Medium/Short term investment plans have been successful thus far. I am considering sitting down with Rich and his associates, or some other planning outfit that I feel I can trust. My issue, is that I want more than a vanilla graph of historic investment trends … USAA told me 6 months ago to get out of gold, that it was too volitile, and that it was due for a fall. I would have lost a nice chunk had I taken that advice.

I post very rarely, but read this blog (and a couple others) pretty religiously. Is a financial planner going to do more for me?

Thanks again for the info (this particular bit, and the last couple years)

[USMCBunny]

Folks,

Thanks so much for the great (and fast) response.

The Last para in the letter states…

“This stock option grant is subject to the terms and conditions set forth in the XXX inc Amended and Restated 2006 Long Term Incentive Stock Option Plan. You should recieve your grant documents for your acceptance via the E*trade system w/in 60 days.”

So – I suppose the vesting sched, and timelines will be in there, I will fire more questions as they come.

As for the professional advice…. I agree in principle. We hired some financial planners about 1.5 years ago. They accepted a check for 1,000.00 and produced a massive folder which basically assumed I had never heard of compound interest, and then tried to sell me overpriced life insurance.

I have the basics down. Long/Medium/Short term investment plans have been successful thus far. I am considering sitting down with Rich and his associates, or some other planning outfit that I feel I can trust. My issue, is that I want more than a vanilla graph of historic investment trends … USAA told me 6 months ago to get out of gold, that it was too volitile, and that it was due for a fall. I would have lost a nice chunk had I taken that advice.

I post very rarely, but read this blog (and a couple others) pretty religiously. Is a financial planner going to do more for me?

Thanks again for the info (this particular bit, and the last couple years)

[USMCBunny]

Folks,

Thanks so much for the great (and fast) response.

The Last para in the letter states…

“This stock option grant is subject to the terms and conditions set forth in the XXX inc Amended and Restated 2006 Long Term Incentive Stock Option Plan. You should recieve your grant documents for your acceptance via the E*trade system w/in 60 days.”

So – I suppose the vesting sched, and timelines will be in there, I will fire more questions as they come.

As for the professional advice…. I agree in principle. We hired some financial planners about 1.5 years ago. They accepted a check for 1,000.00 and produced a massive folder which basically assumed I had never heard of compound interest, and then tried to sell me overpriced life insurance.

I have the basics down. Long/Medium/Short term investment plans have been successful thus far. I am considering sitting down with Rich and his associates, or some other planning outfit that I feel I can trust. My issue, is that I want more than a vanilla graph of historic investment trends … USAA told me 6 months ago to get out of gold, that it was too volitile, and that it was due for a fall. I would have lost a nice chunk had I taken that advice.

I post very rarely, but read this blog (and a couple others) pretty religiously. Is a financial planner going to do more for me?

Thanks again for the info (this particular bit, and the last couple years)

[Raybyrnes]

I would say there is more to it than that. You probably need to find out if these are ISO (sometimes referred to as Statutory or Qualified Option) and NSO (Non Qualified Stock Options. There are a number of different strategies that you can use to maximise the value of a transactions. You can exercise and Hold, exercise and sell along with different combination of the 2.

With 2 working people and your wife moving up the corporate ladder I would pay attention to the ramifications of potentially being hit with AMT (alternative minimum tax)if you generate gains off the options. I would also evaluate the potential of the company and how much exposure you have to this sector.

WIth your wife moving up the best deal might be to find professional assistance. It is typically money well spent.

[Raybyrnes]

I would say there is more to it than that. You probably need to find out if these are ISO (sometimes referred to as Statutory or Qualified Option) and NSO (Non Qualified Stock Options. There are a number of different strategies that you can use to maximise the value of a transactions. You can exercise and Hold, exercise and sell along with different combination of the 2.

With 2 working people and your wife moving up the corporate ladder I would pay attention to the ramifications of potentially being hit with AMT (alternative minimum tax)if you generate gains off the options. I would also evaluate the potential of the company and how much exposure you have to this sector.

WIth your wife moving up the best deal might be to find professional assistance. It is typically money well spent.

[Raybyrnes]

I would say there is more to it than that. You probably need to find out if these are ISO (sometimes referred to as Statutory or Qualified Option) and NSO (Non Qualified Stock Options. There are a number of different strategies that you can use to maximise the value of a transactions. You can exercise and Hold, exercise and sell along with different combination of the 2.

With 2 working people and your wife moving up the corporate ladder I would pay attention to the ramifications of potentially being hit with AMT (alternative minimum tax)if you generate gains off the options. I would also evaluate the potential of the company and how much exposure you have to this sector.

WIth your wife moving up the best deal might be to find professional assistance. It is typically money well spent.

[USMCBunny]

Thanks Raybyrnes … so this is sort of a no lose deal, if the price of the stock goes up, do we buy the stock at the reduced price and then sell them at the higher price? Seems to easy, though, that presupposes the stock will go up. Guess I should check and see.

Flywestcoast

[USMCBunny]

Thanks Raybyrnes … so this is sort of a no lose deal, if the price of the stock goes up, do we buy the stock at the reduced price and then sell them at the higher price? Seems to easy, though, that presupposes the stock will go up. Guess I should check and see.

Flywestcoast

[USMCBunny]

Thanks Raybyrnes … so this is sort of a no lose deal, if the price of the stock goes up, do we buy the stock at the reduced price and then sell them at the higher price? Seems to easy, though, that presupposes the stock will go up. Guess I should check and see.

Flywestcoast

[ucodegen]

@Raybyrnes

Here are some interesting links:

Employee Stock Options Fact Sheet
The Investment FAQ
How Stocks and the Stock Market Work
Stock Links

You’re links don’t seem to be working… what are the raw URLs?

[stockstradr]

My cynical comment on stock options is that I usually hang onto the fancy granting certificate because years later I know it will be valuable…

…valuable that is to take with me camping, to help start a campfire, OR wipe my ass with in the woods if I’ve run out of TP.

I’ve always gotten stock options from the “Premier”

*cough*
*cough*

Blue Chip employers I’ve worked for. Invariably I’ve found those options end up worthless.

My new employer gave me nearly 10,000 options on company stock, vesting in like 4 years, or whatever. Those options remain out-of-the-money.

Of course, if you happen to get some options on the ground floor in a tasty start-up company that becomes wildly successful, you can become a multi-millionaire. I live in Silicon Valley and see plenty of VERY high end sports cars driving around here as proof of that!

[stockstradr]

My cynical comment on stock options is that I usually hang onto the fancy granting certificate because years later I know it will be valuable…

…valuable that is to take with me camping, to help start a campfire, OR wipe my ass with in the woods if I’ve run out of TP.

I’ve always gotten stock options from the “Premier”

*cough*
*cough*

Blue Chip employers I’ve worked for. Invariably I’ve found those options end up worthless.

My new employer gave me nearly 10,000 options on company stock, vesting in like 4 years, or whatever. Those options remain out-of-the-money.

Of course, if you happen to get some options on the ground floor in a tasty start-up company that becomes wildly successful, you can become a multi-millionaire. I live in Silicon Valley and see plenty of VERY high end sports cars driving around here as proof of that!

[stockstradr]

My cynical comment on stock options is that I usually hang onto the fancy granting certificate because years later I know it will be valuable…

…valuable that is to take with me camping, to help start a campfire, OR wipe my ass with in the woods if I’ve run out of TP.

I’ve always gotten stock options from the “Premier”

*cough*
*cough*

Blue Chip employers I’ve worked for. Invariably I’ve found those options end up worthless.

My new employer gave me nearly 10,000 options on company stock, vesting in like 4 years, or whatever. Those options remain out-of-the-money.

Of course, if you happen to get some options on the ground floor in a tasty start-up company that becomes wildly successful, you can become a multi-millionaire. I live in Silicon Valley and see plenty of VERY high end sports cars driving around here as proof of that!

[stockstradr]

My cynical comment on stock options is that I usually hang onto the fancy granting certificate because years later I know it will be valuable…

…valuable that is to take with me camping, to help start a campfire, OR wipe my ass with in the woods if I’ve run out of TP.

I’ve always gotten stock options from the “Premier”

*cough*
*cough*

Blue Chip employers I’ve worked for. Invariably I’ve found those options end up worthless.

My new employer gave me nearly 10,000 options on company stock, vesting in like 4 years, or whatever. Those options remain out-of-the-money.

Of course, if you happen to get some options on the ground floor in a tasty start-up company that becomes wildly successful, you can become a multi-millionaire. I live in Silicon Valley and see plenty of VERY high end sports cars driving around here as proof of that!

[ucodegen]

@Raybyrnes

Here are some interesting links:

Employee Stock Options Fact Sheet
The Investment FAQ
How Stocks and the Stock Market Work
Stock Links

You’re links don’t seem to be working… what are the raw URLs?

[ucodegen]

@Raybyrnes

Here are some interesting links:

Employee Stock Options Fact Sheet
The Investment FAQ
How Stocks and the Stock Market Work
Stock Links

You’re links don’t seem to be working… what are the raw URLs?

[ucodegen]

@Raybyrnes

Here are some interesting links:

Employee Stock Options Fact Sheet
The Investment FAQ
How Stocks and the Stock Market Work
Stock Links

You’re links don’t seem to be working… what are the raw URLs?

[Raybyrnes]

You are granted options so they are yours. You do not have to buy them. In this case they are letting you know your option strike price 26.35. If the price of the stock goes to let’s say 27.35 and you have 1100 option then the value of the option would be $1100 dollars. If on the other hand the stock price is below the 26.35 then they are worthless for now.

For you to see if there is anything to capitalize on you need to find out what the current market price is for the securities. From there you can begin to make some decisions.

How do stock options work?

Job ads in the classifieds mention stock options more and more frequently. Companies are offering this benefit not just to top-paid executives but also to rank-and-file employees. What are stock options? Why are companies offering them? Are employees guaranteed a profit just because they have stock options? The answers to these questions will give you a much better idea about this increasingly popular movement.
Let’s start with a simple definition of stock options:

Stock options from your employer give you the right to buy a specific number of shares of your company’s stock during a time and at a price that your employer specifies.
Both privately and publicly held companies make options available for several reasons:

They want to attract and keep good workers.
They want their employees to feel like owners or partners in the business.
They want to hire skilled workers by offering compensation that goes beyond a salary. This is especially true in start-up companies that want to hold on to as much cash as possible.
The price the company sets on the stock (called the grant or strike price) is discounted and is usually the market price of the stock at the time the employee is given the options. Since those options cannot be exercised for some time, the hope is that the price of the shares will go up so that selling them later at a higher market price will yield a profit. You can see, then, that unless the company goes out of business or doesn’t perform well, offering stock options is a good way to motivate workers to accept jobs and stay on. Those stock options promise potential cash or stock in addition to salary.
Let’s look at a real world example to help you understand how this might work. Say Company X gives or grants its employees options to buy 100 shares of stock at $5 a share. The employees can exercise the options starting Aug. 1, 2001. On Aug. 1, 2001, the stock is at $10. Here are the choices for the employee:

The first thing an employee can do is convert the options to stock, buy it at $5 a share, then turn around and sell all the stock after a waiting period specified in the options’ contract. If an employee sells those 100 shares, that’s a gain of $5 a share, or $500 in profit.
Another thing an employee can do is sell some of the stock after the waiting period and keep some to sell later. Again, the employee has to buy the stock at $5 a share first.
The last choice is to change all the options to stock, buy it at the discounted price and keep it with the idea of selling it later, maybe when each share is worth $15. (Of course, there’s no way to tell if that will ever happen.)
Whatever choice an employee makes, though, the options have to be converted to stock, which brings us to another aspect of stock options: the vesting period. In the example with Company X, employees could exercise their options and buy all 100 shares at once if they wanted to. Usually, though, a company will spread out the vesting period, maybe over three or five or 10 years, and let employees buy so many shares according to a schedule. Here’s how that might work:
You get options on 100 shares of stock in your company.
The vesting schedule for your options is spread out over four years, with one-fourth vested the first year, one-fourth vested the second, one-fourth vested the third, and one-fourth vested the fourth year.
This means you can buy 25 shares at the grant or strike price the first year, then 25 shares each year after until you’re fully vested in the fourth year.
Remember that each year you can buy 25 shares of stock at a discount, then keep it or sell it at the current market value (current stock price). And each year you’re going to hope the stock price continues to rise.
Another thing to know about options is that they always have an expiration date: You can exercise your options starting on a certain date and ending on a certain date. If you don’t exercise the options within that period, you lose them. And if you are leaving a company, you can only exercise your vested options; you will lose any future vesting.

One question you might have is: How does a privately held company establish a market and grant (strike) price on each share of its stock? This might be especially interesting to know if you are or might be working for a small, privately held company that offers stock options. What the company does is to fix a price that is related to the internal value of the share, and this is established by the company’s board of directors through a vote.

Overall, you can see that stock options do have risk, and they are not always better than cash compensation if the company is not successful, but they are becoming a built-in feature in many industries.

Here are some interesting links:

Employee Stock Options Fact Sheet
The Investment FAQ
How Stocks and the Stock Market Work
Stock Links

[Raybyrnes]

You are granted options so they are yours. You do not have to buy them. In this case they are letting you know your option strike price 26.35. If the price of the stock goes to let’s say 27.35 and you have 1100 option then the value of the option would be $1100 dollars. If on the other hand the stock price is below the 26.35 then they are worthless for now.

For you to see if there is anything to capitalize on you need to find out what the current market price is for the securities. From there you can begin to make some decisions.

How do stock options work?

Job ads in the classifieds mention stock options more and more frequently. Companies are offering this benefit not just to top-paid executives but also to rank-and-file employees. What are stock options? Why are companies offering them? Are employees guaranteed a profit just because they have stock options? The answers to these questions will give you a much better idea about this increasingly popular movement.
Let’s start with a simple definition of stock options:

Stock options from your employer give you the right to buy a specific number of shares of your company’s stock during a time and at a price that your employer specifies.
Both privately and publicly held companies make options available for several reasons:

They want to attract and keep good workers.
They want their employees to feel like owners or partners in the business.
They want to hire skilled workers by offering compensation that goes beyond a salary. This is especially true in start-up companies that want to hold on to as much cash as possible.
The price the company sets on the stock (called the grant or strike price) is discounted and is usually the market price of the stock at the time the employee is given the options. Since those options cannot be exercised for some time, the hope is that the price of the shares will go up so that selling them later at a higher market price will yield a profit. You can see, then, that unless the company goes out of business or doesn’t perform well, offering stock options is a good way to motivate workers to accept jobs and stay on. Those stock options promise potential cash or stock in addition to salary.
Let’s look at a real world example to help you understand how this might work. Say Company X gives or grants its employees options to buy 100 shares of stock at $5 a share. The employees can exercise the options starting Aug. 1, 2001. On Aug. 1, 2001, the stock is at $10. Here are the choices for the employee:

The first thing an employee can do is convert the options to stock, buy it at $5 a share, then turn around and sell all the stock after a waiting period specified in the options’ contract. If an employee sells those 100 shares, that’s a gain of $5 a share, or $500 in profit.
Another thing an employee can do is sell some of the stock after the waiting period and keep some to sell later. Again, the employee has to buy the stock at $5 a share first.
The last choice is to change all the options to stock, buy it at the discounted price and keep it with the idea of selling it later, maybe when each share is worth $15. (Of course, there’s no way to tell if that will ever happen.)
Whatever choice an employee makes, though, the options have to be converted to stock, which brings us to another aspect of stock options: the vesting period. In the example with Company X, employees could exercise their options and buy all 100 shares at once if they wanted to. Usually, though, a company will spread out the vesting period, maybe over three or five or 10 years, and let employees buy so many shares according to a schedule. Here’s how that might work:
You get options on 100 shares of stock in your company.
The vesting schedule for your options is spread out over four years, with one-fourth vested the first year, one-fourth vested the second, one-fourth vested the third, and one-fourth vested the fourth year.
This means you can buy 25 shares at the grant or strike price the first year, then 25 shares each year after until you’re fully vested in the fourth year.
Remember that each year you can buy 25 shares of stock at a discount, then keep it or sell it at the current market value (current stock price). And each year you’re going to hope the stock price continues to rise.
Another thing to know about options is that they always have an expiration date: You can exercise your options starting on a certain date and ending on a certain date. If you don’t exercise the options within that period, you lose them. And if you are leaving a company, you can only exercise your vested options; you will lose any future vesting.

One question you might have is: How does a privately held company establish a market and grant (strike) price on each share of its stock? This might be especially interesting to know if you are or might be working for a small, privately held company that offers stock options. What the company does is to fix a price that is related to the internal value of the share, and this is established by the company’s board of directors through a vote.

Overall, you can see that stock options do have risk, and they are not always better than cash compensation if the company is not successful, but they are becoming a built-in feature in many industries.

Here are some interesting links:

Employee Stock Options Fact Sheet
The Investment FAQ
How Stocks and the Stock Market Work
Stock Links

[Raybyrnes]

You are granted options so they are yours. You do not have to buy them. In this case they are letting you know your option strike price 26.35. If the price of the stock goes to let’s say 27.35 and you have 1100 option then the value of the option would be $1100 dollars. If on the other hand the stock price is below the 26.35 then they are worthless for now.

For you to see if there is anything to capitalize on you need to find out what the current market price is for the securities. From there you can begin to make some decisions.

How do stock options work?

Job ads in the classifieds mention stock options more and more frequently. Companies are offering this benefit not just to top-paid executives but also to rank-and-file employees. What are stock options? Why are companies offering them? Are employees guaranteed a profit just because they have stock options? The answers to these questions will give you a much better idea about this increasingly popular movement.
Let’s start with a simple definition of stock options:

Stock options from your employer give you the right to buy a specific number of shares of your company’s stock during a time and at a price that your employer specifies.
Both privately and publicly held companies make options available for several reasons:

They want to attract and keep good workers.
They want their employees to feel like owners or partners in the business.
They want to hire skilled workers by offering compensation that goes beyond a salary. This is especially true in start-up companies that want to hold on to as much cash as possible.
The price the company sets on the stock (called the grant or strike price) is discounted and is usually the market price of the stock at the time the employee is given the options. Since those options cannot be exercised for some time, the hope is that the price of the shares will go up so that selling them later at a higher market price will yield a profit. You can see, then, that unless the company goes out of business or doesn’t perform well, offering stock options is a good way to motivate workers to accept jobs and stay on. Those stock options promise potential cash or stock in addition to salary.
Let’s look at a real world example to help you understand how this might work. Say Company X gives or grants its employees options to buy 100 shares of stock at $5 a share. The employees can exercise the options starting Aug. 1, 2001. On Aug. 1, 2001, the stock is at $10. Here are the choices for the employee:

The first thing an employee can do is convert the options to stock, buy it at $5 a share, then turn around and sell all the stock after a waiting period specified in the options’ contract. If an employee sells those 100 shares, that’s a gain of $5 a share, or $500 in profit.
Another thing an employee can do is sell some of the stock after the waiting period and keep some to sell later. Again, the employee has to buy the stock at $5 a share first.
The last choice is to change all the options to stock, buy it at the discounted price and keep it with the idea of selling it later, maybe when each share is worth $15. (Of course, there’s no way to tell if that will ever happen.)
Whatever choice an employee makes, though, the options have to be converted to stock, which brings us to another aspect of stock options: the vesting period. In the example with Company X, employees could exercise their options and buy all 100 shares at once if they wanted to. Usually, though, a company will spread out the vesting period, maybe over three or five or 10 years, and let employees buy so many shares according to a schedule. Here’s how that might work:
You get options on 100 shares of stock in your company.
The vesting schedule for your options is spread out over four years, with one-fourth vested the first year, one-fourth vested the second, one-fourth vested the third, and one-fourth vested the fourth year.
This means you can buy 25 shares at the grant or strike price the first year, then 25 shares each year after until you’re fully vested in the fourth year.
Remember that each year you can buy 25 shares of stock at a discount, then keep it or sell it at the current market value (current stock price). And each year you’re going to hope the stock price continues to rise.
Another thing to know about options is that they always have an expiration date: You can exercise your options starting on a certain date and ending on a certain date. If you don’t exercise the options within that period, you lose them. And if you are leaving a company, you can only exercise your vested options; you will lose any future vesting.

One question you might have is: How does a privately held company establish a market and grant (strike) price on each share of its stock? This might be especially interesting to know if you are or might be working for a small, privately held company that offers stock options. What the company does is to fix a price that is related to the internal value of the share, and this is established by the company’s board of directors through a vote.

Overall, you can see that stock options do have risk, and they are not always better than cash compensation if the company is not successful, but they are becoming a built-in feature in many industries.

Here are some interesting links:

Employee Stock Options Fact Sheet
The Investment FAQ
How Stocks and the Stock Market Work
Stock Links

[Daniel]

There should also be an expiration date (sometime far in the future, not Sep 2007, which is the grant date). Also, it should be clear from the text whether she’s got options for 1,100 shares (that would be 11 standard contracts), or perhaps more.

Whenever she exercises the options, she will get 1,100*(stock price on that date – $26.35), if stock price is above $26.35, or nothing otherwise. She can exercise up to the expiration date. However, there are lots and lots of tax implications on option awards, and it may be very complicated (due to tax issues) to decide what the best course of action is. There may also be strings attached.

PS: yes, this is certainly an opportunity to invest in the company she works for. Whether it’s a good or bad investment, only future will tell.

[Daniel]

Sorry, I see Ray pretty much covered it all. Ray, you type damn fast 🙂

[Daniel]

Sorry, I see Ray pretty much covered it all. Ray, you type damn fast 🙂

[Daniel]

Sorry, I see Ray pretty much covered it all. Ray, you type damn fast 🙂

[Daniel]

Sorry, I see Ray pretty much covered it all. Ray, you type damn fast 🙂

[Daniel]

There should also be an expiration date (sometime far in the future, not Sep 2007, which is the grant date). Also, it should be clear from the text whether she’s got options for 1,100 shares (that would be 11 standard contracts), or perhaps more.

Whenever she exercises the options, she will get 1,100*(stock price on that date – $26.35), if stock price is above $26.35, or nothing otherwise. She can exercise up to the expiration date. However, there are lots and lots of tax implications on option awards, and it may be very complicated (due to tax issues) to decide what the best course of action is. There may also be strings attached.

PS: yes, this is certainly an opportunity to invest in the company she works for. Whether it’s a good or bad investment, only future will tell.

[Daniel]

There should also be an expiration date (sometime far in the future, not Sep 2007, which is the grant date). Also, it should be clear from the text whether she’s got options for 1,100 shares (that would be 11 standard contracts), or perhaps more.

Whenever she exercises the options, she will get 1,100*(stock price on that date – $26.35), if stock price is above $26.35, or nothing otherwise. She can exercise up to the expiration date. However, there are lots and lots of tax implications on option awards, and it may be very complicated (due to tax issues) to decide what the best course of action is. There may also be strings attached.

PS: yes, this is certainly an opportunity to invest in the company she works for. Whether it’s a good or bad investment, only future will tell.

[Daniel]

There should also be an expiration date (sometime far in the future, not Sep 2007, which is the grant date). Also, it should be clear from the text whether she’s got options for 1,100 shares (that would be 11 standard contracts), or perhaps more.

Whenever she exercises the options, she will get 1,100*(stock price on that date – $26.35), if stock price is above $26.35, or nothing otherwise. She can exercise up to the expiration date. However, there are lots and lots of tax implications on option awards, and it may be very complicated (due to tax issues) to decide what the best course of action is. There may also be strings attached.

PS: yes, this is certainly an opportunity to invest in the company she works for. Whether it’s a good or bad investment, only future will tell.

[Coronita]

I have a lot of things to say about stock options from my own experience and colleagues. But I'm at work. If you wait I'll post about them later tonight. The thing you want to make sure is you want to find out whether they are either

1) ISO (Incentive stock options)

or  

2) NQ (Non-qualified stock options) 

There are different tax consequences when it comes to exercising the two different stock options and whether you decide to sell right away or hold on. You have to be careful that you don't fall into an AMT tax trap situation if they are ISO(#1). Basically, this is an weird situation when you end up owing more taxes than the value of the exercised stock options themselves. Yes, it's possible, although I doubt in the current market conditions would it occur… This was a phenoma of the dot.com  when you're issued a lot of stock options that are at the time of exercise worth a lot of money but then subsequently fall when you actually sell it.

[Coronita]

I have a lot of things to say about stock options from my own experience and colleagues. But I'm at work. If you wait I'll post about them later tonight. The thing you want to make sure is you want to find out whether they are either

1) ISO (Incentive stock options)

or  

2) NQ (Non-qualified stock options) 

There are different tax consequences when it comes to exercising the two different stock options and whether you decide to sell right away or hold on. You have to be careful that you don't fall into an AMT tax trap situation if they are ISO(#1). Basically, this is an weird situation when you end up owing more taxes than the value of the exercised stock options themselves. Yes, it's possible, although I doubt in the current market conditions would it occur… This was a phenoma of the dot.com  when you're issued a lot of stock options that are at the time of exercise worth a lot of money but then subsequently fall when you actually sell it.

[Coronita]

I have a lot of things to say about stock options from my own experience and colleagues. But I'm at work. If you wait I'll post about them later tonight. The thing you want to make sure is you want to find out whether they are either

1) ISO (Incentive stock options)

or  

2) NQ (Non-qualified stock options) 

There are different tax consequences when it comes to exercising the two different stock options and whether you decide to sell right away or hold on. You have to be careful that you don't fall into an AMT tax trap situation if they are ISO(#1). Basically, this is an weird situation when you end up owing more taxes than the value of the exercised stock options themselves. Yes, it's possible, although I doubt in the current market conditions would it occur… This was a phenoma of the dot.com  when you're issued a lot of stock options that are at the time of exercise worth a lot of money but then subsequently fall when you actually sell it.

[Coronita]

I have a lot of things to say about stock options from my own experience and colleagues. But I'm at work. If you wait I'll post about them later tonight. The thing you want to make sure is you want to find out whether they are either

1) ISO (Incentive stock options)

or  

2) NQ (Non-qualified stock options) 

There are different tax consequences when it comes to exercising the two different stock options and whether you decide to sell right away or hold on. You have to be careful that you don't fall into an AMT tax trap situation if they are ISO(#1). Basically, this is an weird situation when you end up owing more taxes than the value of the exercised stock options themselves. Yes, it's possible, although I doubt in the current market conditions would it occur… This was a phenoma of the dot.com  when you're issued a lot of stock options that are at the time of exercise worth a lot of money but then subsequently fall when you actually sell it.

[Coronita]

USMCBunny,

 

Sorry for not getting back to you sooner. I've been busy at work. I’ve worked a several companies both here and in the bay area to gone through the entire gamut of stock options.

 

Raybarnes did an excellent job explaining stock options.

I'll try to add additional information to what he said, particularly

regarding taxes. If this gets too confusing, consult a CPA/tax accountant. BTW: I’m not a cpa, so please confirm everything with someone who is.

 

 

Basic:

Stock options are a benefit a company gives to employees. They are rights for employees to buy company stock in the future at a set price. In your wife's example, her company gave her the right to buy 1100 shares in the future at $26.35. The purpose of stock options is to persuade the employee to stick around and to worker harder to push the earnings and hence stock price above the options price. The price at which you can buy the shares is called the “exercise” price. It is largely determined by luck (IE the day you join the company, or the day you are granted the stock options), although you can slightly time things when you join a company that has seasonal stock price swings.

 

Now, generally you will have to wait before you can do use these stock options. This is called “vesting”. Typically, companies spell out how long you have to wait before you can exercise a portion of the stock options. Typically, a stock option grant vests over a 4 year period, with the first 25% of the share amount available after 1 year front the date your give the option, and then 25%/12 month to month for the remaining 4 years. NOTE: sometimes this is negotiable, depending on the size of the company and how important you are.So… If your wife’s company stock is currently trading at $125/share don’t go celebrating right now and go on a shopping spree, because chances are she has to wait at least 1 year before she can do anything with them…and a lot can happen in a year…Similarly, if the current stock price is less than $26.35, her options are currently worthless (AKA underwater), but don’t be bummed yet, because she can’t do anything with them until she vests. And even if she vests, companies typically give a few years before you HAVE to do something. Qualcomm for example gives a few years after you vest before you have to exercise the options (otherwise they disappear).

 

 

Tax Consequences:

 

As long as you don’t exercise the stock options, you don’t have tax consequences. The moment you decide to exercise a stock option and buy the company stock, your tax consequences depends on

A) the type of stock option

AND

B) whether you decide to hold on to the stock or sell it.

 

 

 

There are two types of stock options

Non-qualified Stock Options (NQ)

Incentive Stock Options: (ISO)

 

The tax consequences are different for the different type of options

 

1) Non Qualified are the easiest to understand.

 

Let’s use a hypothetical example.

 

*Let’s say your wife exercises her stock options 1/1/2008 at $26.35/shares and 10000 shares.

*The day she exercise (1/1/2008), the stock prices is $56.35/shares.

 

 

Regardless of whether she holds onto the stock or sells it right away, the difference between the fair market value the day she execised and the stock option price will be taxed at ordinary income and should appear on a W2.

That is $56350-26350= $30000 will be taxed as ordinary income.

 

Now, what happens thereafter depends on when she sells those 10000 shares.

1a) She sells the same day. Well, she has no other tax consequences. The $30000 is all taxed as ordinary income.

1b) She sells the 10000 shares at a later day, but before 1 year. The difference between the stock price the day she sells it and the stock price the day she exercised is taxed as either short term capital gain or loss.

1b1) Let’s say she sells the shares 11/1/2008, and the stock price is $66.35. Recall, the day she exercised her options, the stock price was $56.35. She would have a short term capital gain of ($66.35-$56.35)x10000 , or $10,000 would be taxed as short term capital gains, in addition to the $30,000 she was taxed as ordinary income. This is fair, because in reality, she made $40,000 total.

1b2)Let’s say she sells the shares 11/1/2007 and that day, the stock price is $46.35, below the $56.35 price the day she exercised.

**$30,000 will be taxed as ordinary income tax as before (56.35-26.35) x 10000= $30k .

**$10,000 will be short term capital loss (46.35-56.35)x10000= $10k short term capital loss. …. And here lies the issue. IRS limits the maximum capital loss you can take each year before you have to carry it over to the next year (I think its $3k). So while you have to pay taxes on $30k you really didn’t earn, you can use the $10k capital loss to only offset any other capital gains up to a total $3k of the short term loss that year. You have to carry over the remaining losses next year.

 

 

1c) She sells the 10000 shares after 1 year… You have to pay ordinary income taxes on $30k this year. Then you pay long term capital gain taxes or accrue long term capital losses successive years, similar to 1b1, 1b2. You’re being asked to pay ordinary income taxes up front, but any capital losses in the future are limited to the $3k limit before the remaining amount is carried over to following years.

 

Here’s an article that describes this in detail

http://www.quicken.com/cms/viewers/article/taxes/33890

 

 

2) Incentive Stock Options (ISO) are by far the most complicated, and a lot of people in the Dot Com got burned by AMT with them. Usually, mature companies don’t give out ISO anymore, but in case you run into them…

 

The key difference is that exercising ISO’s are not computed as part of regular income tax. BUT, ISO’s are used in AMT tax (alternative minimum tax). If you don’t know what AMT is, I suggest you read up on it.

 

 

Let’s use a hypothetical example.

 

*Let’s say your wife exercises her ISO stock options 1/1/2008 at $26.35/shares and 10000 shares.

*The day she exercise (1/1/2008), the stock prices is $56.35/shares.

 

*Suppose she decides to hold onto the stock for a year.

While the difference between the market price the day she exercised and her option price x10000 shares (IE $30,000) isn’t subject to ordinary income tax, it WILL be used in computing AMT. AMT tax rates are very interesting…you should expect to pay AMT as large as 28% if the spread between your option price and the Fair Market Value of the stock the day you exercised is very large. (The maximum rate for the AMT is 28%, but the tax resulting from a single large item can be greater than that percentage because of the interaction of various features of the alternative minimum tax.)

 

The second consequence from the AMT adjustment is that some or all of your AMT liability will be eligible for use as a credit in future years. This credit can only be used in years when you don't pay AMT. It's called the AMT credit, but it reduces your regular tax, not your AMT. In the best case, the AMT credit will eventually permit you to recover all of the AMT you paid in the year you exercised your incentive stock option. When that happens, the only effect of the AMT was to make you pay tax sooner, not to make you pay more tax than you would have paid. But for various reasons you can't count on being able to recover all of the AMT in later years.

 

You can avoid this by doing a same day sell on ISO’s. If you do decide to hold on, you should really consult an accountant, because there are other gotchas related to AMT, that I don’t feel competent to explain here.

 

I speak particularly of AMT and ISO, because one of the startups I worked at in the bay area had precisely this issue. We were granted stock options at $30/share pre-ipo. The first day of trading, we closed at $307/share, and a lot of people decided to exercise 10-20k shares that day. Due to lockup of insider shares, they could not trade the first day(90 days, if my memory serves me), and chose to hold on longer than a year for favorable long term cap gains . But thefFollowing year, stock tanked to about $150/share..So a lot of people got screwed ,because they paid a lot of AMT the first year, but could not recover the capital losses (or I should say, they have lifetime capital loss carryover). It financially devastated a lot of people, because they couldnt pay the AMT tax bill.

 

Here's an abbreviated article on what happened to some people. It was quite common. http://irslaw.org/iso_amt.htm

One of the key lessons to learn if your sitting on a wad of in-the-money stock options is don't be greedy, and don't go for that long term cap gains. It might not work to your advantage.

There are other things you want to manage as well, when you are heavily invested in the company you work for. Namely, watch out for have stock options, holding onto ESPP shares, buying company shares in 401k plans, and buying company stock in personal accounts all at the same time. A lot of enron/worldcon/CFC people I'm sure did this, and pissed everything away, and on top of that lost their job. Don't be greedy is the lesson.

Lastly, if you have in-the money stock options that are worth a lot but you haven't fully vested and are afraid that by the time you can vest, you company's stock might be worthless, I would consider hedging the stock options the company grants you buy buying short term put options, provided company policy doesn't forbid you in trading derivatives. Then, the only things that can happen to screw you is if you get dismissed before vesting.

 

[djrobsd]

Agree 100% with fat_lazy_union. The ONLY way to go with your stock options when they become worth something is to do a same day sale. Don’t be greedy, don’t hold them expecting the value to go up because it could go down. Lately, most good IPO’s have seen their stock go up 50-100% in the following months beyond their IPO. However, after that, a lot of the investors want to cash out, and then your stock drops down to below your strike price, and you have nothing but a piece of paper.

Stock options suck. Many companies back in the .com days used them instead of salary, so an employee who would normally earn $100,000 per year would get like 100k options and a salary of 50k per year instead. This was great when the market was good, but these days you’ll never see that.

Most technology companies are granting about 750 shares to their lowest level employees (clerks, order processors, receptionists, etc), 1000 shares to jr level sales and marketing positions, 2500-3000 shares to IT workers and programmers, 5000 to entry level managers (supervisors, and managers at the lower end of the payscale), 10,000 to more senior management, 50,000 to VP level management, and 250,000 to the CIO, CFO, CTO, etc.

The reason for this is that the IRS recently changed the tax codes and stock options are now a major liability on a company’s books, so they cost a lot more to grant (even if they are not in the money), whereas before the company could grant all the options they wanted and they didn’t have to expense them until they were actually exercised. It’s something called FAS123R if you’re bored and want to look it up on google. LOL

So, from my example there, usually only the highest up in the company stand to gain from the stock options. They will often times get lower strike prices then the ordinary employees too.

Stock options are designed to make the rich people richer. The average joe doesn’t do too well with stock options these days.

[Raybyrnes]

I don’t know about stock option being useless. They weren’t designed to be an addaboy for a job well done but rather an incentive to get the get the job done. They look forward as opposed to looking back. To me if you embrace the company and buy in you should want to work to make the options valuable. If your in sales go sell, if you are in accounting, hammer recievables if you operations negotiate with vendors. You have a way of impacting the bottom line.

I come from a team sport background so I believe that that everyone counts. When all energies are focused on a common goal those option can be made to worth something. You can’t change the structure so you can be negative or you can be positive. I choose to be positive.

[Raybyrnes]

I don’t know about stock option being useless. They weren’t designed to be an addaboy for a job well done but rather an incentive to get the get the job done. They look forward as opposed to looking back. To me if you embrace the company and buy in you should want to work to make the options valuable. If your in sales go sell, if you are in accounting, hammer recievables if you operations negotiate with vendors. You have a way of impacting the bottom line.

I come from a team sport background so I believe that that everyone counts. When all energies are focused on a common goal those option can be made to worth something. You can’t change the structure so you can be negative or you can be positive. I choose to be positive.

[Raybyrnes]

I don’t know about stock option being useless. They weren’t designed to be an addaboy for a job well done but rather an incentive to get the get the job done. They look forward as opposed to looking back. To me if you embrace the company and buy in you should want to work to make the options valuable. If your in sales go sell, if you are in accounting, hammer recievables if you operations negotiate with vendors. You have a way of impacting the bottom line.

I come from a team sport background so I believe that that everyone counts. When all energies are focused on a common goal those option can be made to worth something. You can’t change the structure so you can be negative or you can be positive. I choose to be positive.

[Raybyrnes]

I don’t know about stock option being useless. They weren’t designed to be an addaboy for a job well done but rather an incentive to get the get the job done. They look forward as opposed to looking back. To me if you embrace the company and buy in you should want to work to make the options valuable. If your in sales go sell, if you are in accounting, hammer recievables if you operations negotiate with vendors. You have a way of impacting the bottom line.

I come from a team sport background so I believe that that everyone counts. When all energies are focused on a common goal those option can be made to worth something. You can’t change the structure so you can be negative or you can be positive. I choose to be positive.

[djrobsd]

Agree 100% with fat_lazy_union. The ONLY way to go with your stock options when they become worth something is to do a same day sale. Don’t be greedy, don’t hold them expecting the value to go up because it could go down. Lately, most good IPO’s have seen their stock go up 50-100% in the following months beyond their IPO. However, after that, a lot of the investors want to cash out, and then your stock drops down to below your strike price, and you have nothing but a piece of paper.

Stock options suck. Many companies back in the .com days used them instead of salary, so an employee who would normally earn $100,000 per year would get like 100k options and a salary of 50k per year instead. This was great when the market was good, but these days you’ll never see that.

Most technology companies are granting about 750 shares to their lowest level employees (clerks, order processors, receptionists, etc), 1000 shares to jr level sales and marketing positions, 2500-3000 shares to IT workers and programmers, 5000 to entry level managers (supervisors, and managers at the lower end of the payscale), 10,000 to more senior management, 50,000 to VP level management, and 250,000 to the CIO, CFO, CTO, etc.

The reason for this is that the IRS recently changed the tax codes and stock options are now a major liability on a company’s books, so they cost a lot more to grant (even if they are not in the money), whereas before the company could grant all the options they wanted and they didn’t have to expense them until they were actually exercised. It’s something called FAS123R if you’re bored and want to look it up on google. LOL

So, from my example there, usually only the highest up in the company stand to gain from the stock options. They will often times get lower strike prices then the ordinary employees too.

Stock options are designed to make the rich people richer. The average joe doesn’t do too well with stock options these days.

[djrobsd]

Agree 100% with fat_lazy_union. The ONLY way to go with your stock options when they become worth something is to do a same day sale. Don’t be greedy, don’t hold them expecting the value to go up because it could go down. Lately, most good IPO’s have seen their stock go up 50-100% in the following months beyond their IPO. However, after that, a lot of the investors want to cash out, and then your stock drops down to below your strike price, and you have nothing but a piece of paper.

Stock options suck. Many companies back in the .com days used them instead of salary, so an employee who would normally earn $100,000 per year would get like 100k options and a salary of 50k per year instead. This was great when the market was good, but these days you’ll never see that.

Most technology companies are granting about 750 shares to their lowest level employees (clerks, order processors, receptionists, etc), 1000 shares to jr level sales and marketing positions, 2500-3000 shares to IT workers and programmers, 5000 to entry level managers (supervisors, and managers at the lower end of the payscale), 10,000 to more senior management, 50,000 to VP level management, and 250,000 to the CIO, CFO, CTO, etc.

The reason for this is that the IRS recently changed the tax codes and stock options are now a major liability on a company’s books, so they cost a lot more to grant (even if they are not in the money), whereas before the company could grant all the options they wanted and they didn’t have to expense them until they were actually exercised. It’s something called FAS123R if you’re bored and want to look it up on google. LOL

So, from my example there, usually only the highest up in the company stand to gain from the stock options. They will often times get lower strike prices then the ordinary employees too.

Stock options are designed to make the rich people richer. The average joe doesn’t do too well with stock options these days.

[djrobsd]

Agree 100% with fat_lazy_union. The ONLY way to go with your stock options when they become worth something is to do a same day sale. Don’t be greedy, don’t hold them expecting the value to go up because it could go down. Lately, most good IPO’s have seen their stock go up 50-100% in the following months beyond their IPO. However, after that, a lot of the investors want to cash out, and then your stock drops down to below your strike price, and you have nothing but a piece of paper.

Stock options suck. Many companies back in the .com days used them instead of salary, so an employee who would normally earn $100,000 per year would get like 100k options and a salary of 50k per year instead. This was great when the market was good, but these days you’ll never see that.

Most technology companies are granting about 750 shares to their lowest level employees (clerks, order processors, receptionists, etc), 1000 shares to jr level sales and marketing positions, 2500-3000 shares to IT workers and programmers, 5000 to entry level managers (supervisors, and managers at the lower end of the payscale), 10,000 to more senior management, 50,000 to VP level management, and 250,000 to the CIO, CFO, CTO, etc.

The reason for this is that the IRS recently changed the tax codes and stock options are now a major liability on a company’s books, so they cost a lot more to grant (even if they are not in the money), whereas before the company could grant all the options they wanted and they didn’t have to expense them until they were actually exercised. It’s something called FAS123R if you’re bored and want to look it up on google. LOL

So, from my example there, usually only the highest up in the company stand to gain from the stock options. They will often times get lower strike prices then the ordinary employees too.

Stock options are designed to make the rich people richer. The average joe doesn’t do too well with stock options these days.

[Coronita]

USMCBunny,

 

Sorry for not getting back to you sooner. I've been busy at work. I’ve worked a several companies both here and in the bay area to gone through the entire gamut of stock options.

 

Raybarnes did an excellent job explaining stock options.

I'll try to add additional information to what he said, particularly

regarding taxes. If this gets too confusing, consult a CPA/tax accountant. BTW: I’m not a cpa, so please confirm everything with someone who is.

 

 

Basic:

Stock options are a benefit a company gives to employees. They are rights for employees to buy company stock in the future at a set price. In your wife's example, her company gave her the right to buy 1100 shares in the future at $26.35. The purpose of stock options is to persuade the employee to stick around and to worker harder to push the earnings and hence stock price above the options price. The price at which you can buy the shares is called the “exercise” price. It is largely determined by luck (IE the day you join the company, or the day you are granted the stock options), although you can slightly time things when you join a company that has seasonal stock price swings.

 

Now, generally you will have to wait before you can do use these stock options. This is called “vesting”. Typically, companies spell out how long you have to wait before you can exercise a portion of the stock options. Typically, a stock option grant vests over a 4 year period, with the first 25% of the share amount available after 1 year front the date your give the option, and then 25%/12 month to month for the remaining 4 years. NOTE: sometimes this is negotiable, depending on the size of the company and how important you are.So… If your wife’s company stock is currently trading at $125/share don’t go celebrating right now and go on a shopping spree, because chances are she has to wait at least 1 year before she can do anything with them…and a lot can happen in a year…Similarly, if the current stock price is less than $26.35, her options are currently worthless (AKA underwater), but don’t be bummed yet, because she can’t do anything with them until she vests. And even if she vests, companies typically give a few years before you HAVE to do something. Qualcomm for example gives a few years after you vest before you have to exercise the options (otherwise they disappear).

 

 

Tax Consequences:

 

As long as you don’t exercise the stock options, you don’t have tax consequences. The moment you decide to exercise a stock option and buy the company stock, your tax consequences depends on

A) the type of stock option

AND

B) whether you decide to hold on to the stock or sell it.

 

 

 

There are two types of stock options

Non-qualified Stock Options (NQ)

Incentive Stock Options: (ISO)

 

The tax consequences are different for the different type of options

 

1) Non Qualified are the easiest to understand.

 

Let’s use a hypothetical example.

 

*Let’s say your wife exercises her stock options 1/1/2008 at $26.35/shares and 10000 shares.

*The day she exercise (1/1/2008), the stock prices is $56.35/shares.

 

 

Regardless of whether she holds onto the stock or sells it right away, the difference between the fair market value the day she execised and the stock option price will be taxed at ordinary income and should appear on a W2.

That is $56350-26350= $30000 will be taxed as ordinary income.

 

Now, what happens thereafter depends on when she sells those 10000 shares.

1a) She sells the same day. Well, she has no other tax consequences. The $30000 is all taxed as ordinary income.

1b) She sells the 10000 shares at a later day, but before 1 year. The difference between the stock price the day she sells it and the stock price the day she exercised is taxed as either short term capital gain or loss.

1b1) Let’s say she sells the shares 11/1/2008, and the stock price is $66.35. Recall, the day she exercised her options, the stock price was $56.35. She would have a short term capital gain of ($66.35-$56.35)x10000 , or $10,000 would be taxed as short term capital gains, in addition to the $30,000 she was taxed as ordinary income. This is fair, because in reality, she made $40,000 total.

1b2)Let’s say she sells the shares 11/1/2007 and that day, the stock price is $46.35, below the $56.35 price the day she exercised.

**$30,000 will be taxed as ordinary income tax as before (56.35-26.35) x 10000= $30k .

**$10,000 will be short term capital loss (46.35-56.35)x10000= $10k short term capital loss. …. And here lies the issue. IRS limits the maximum capital loss you can take each year before you have to carry it over to the next year (I think its $3k). So while you have to pay taxes on $30k you really didn’t earn, you can use the $10k capital loss to only offset any other capital gains up to a total $3k of the short term loss that year. You have to carry over the remaining losses next year.

 

 

1c) She sells the 10000 shares after 1 year… You have to pay ordinary income taxes on $30k this year. Then you pay long term capital gain taxes or accrue long term capital losses successive years, similar to 1b1, 1b2. You’re being asked to pay ordinary income taxes up front, but any capital losses in the future are limited to the $3k limit before the remaining amount is carried over to following years.

 

Here’s an article that describes this in detail

http://www.quicken.com/cms/viewers/article/taxes/33890

 

 

2) Incentive Stock Options (ISO) are by far the most complicated, and a lot of people in the Dot Com got burned by AMT with them. Usually, mature companies don’t give out ISO anymore, but in case you run into them…

 

The key difference is that exercising ISO’s are not computed as part of regular income tax. BUT, ISO’s are used in AMT tax (alternative minimum tax). If you don’t know what AMT is, I suggest you read up on it.

 

 

Let’s use a hypothetical example.

 

*Let’s say your wife exercises her ISO stock options 1/1/2008 at $26.35/shares and 10000 shares.

*The day she exercise (1/1/2008), the stock prices is $56.35/shares.

 

*Suppose she decides to hold onto the stock for a year.

While the difference between the market price the day she exercised and her option price x10000 shares (IE $30,000) isn’t subject to ordinary income tax, it WILL be used in computing AMT. AMT tax rates are very interesting…you should expect to pay AMT as large as 28% if the spread between your option price and the Fair Market Value of the stock the day you exercised is very large. (The maximum rate for the AMT is 28%, but the tax resulting from a single large item can be greater than that percentage because of the interaction of various features of the alternative minimum tax.)

 

The second consequence from the AMT adjustment is that some or all of your AMT liability will be eligible for use as a credit in future years. This credit can only be used in years when you don't pay AMT. It's called the AMT credit, but it reduces your regular tax, not your AMT. In the best case, the AMT credit will eventually permit you to recover all of the AMT you paid in the year you exercised your incentive stock option. When that happens, the only effect of the AMT was to make you pay tax sooner, not to make you pay more tax than you would have paid. But for various reasons you can't count on being able to recover all of the AMT in later years.

 

You can avoid this by doing a same day sell on ISO’s. If you do decide to hold on, you should really consult an accountant, because there are other gotchas related to AMT, that I don’t feel competent to explain here.

 

I speak particularly of AMT and ISO, because one of the startups I worked at in the bay area had precisely this issue. We were granted stock options at $30/share pre-ipo. The first day of trading, we closed at $307/share, and a lot of people decided to exercise 10-20k shares that day. Due to lockup of insider shares, they could not trade the first day(90 days, if my memory serves me), and chose to hold on longer than a year for favorable long term cap gains . But thefFollowing year, stock tanked to about $150/share..So a lot of people got screwed ,because they paid a lot of AMT the first year, but could not recover the capital losses (or I should say, they have lifetime capital loss carryover). It financially devastated a lot of people, because they couldnt pay the AMT tax bill.

 

Here's an abbreviated article on what happened to some people. It was quite common. http://irslaw.org/iso_amt.htm

One of the key lessons to learn if your sitting on a wad of in-the-money stock options is don't be greedy, and don't go for that long term cap gains. It might not work to your advantage.

There are other things you want to manage as well, when you are heavily invested in the company you work for. Namely, watch out for have stock options, holding onto ESPP shares, buying company shares in 401k plans, and buying company stock in personal accounts all at the same time. A lot of enron/worldcon/CFC people I'm sure did this, and pissed everything away, and on top of that lost their job. Don't be greedy is the lesson.

Lastly, if you have in-the money stock options that are worth a lot but you haven't fully vested and are afraid that by the time you can vest, you company's stock might be worthless, I would consider hedging the stock options the company grants you buy buying short term put options, provided company policy doesn't forbid you in trading derivatives. Then, the only things that can happen to screw you is if you get dismissed before vesting.

 

[Coronita]

USMCBunny,

 

Sorry for not getting back to you sooner. I've been busy at work. I’ve worked a several companies both here and in the bay area to gone through the entire gamut of stock options.

 

Raybarnes did an excellent job explaining stock options.

I'll try to add additional information to what he said, particularly

regarding taxes. If this gets too confusing, consult a CPA/tax accountant. BTW: I’m not a cpa, so please confirm everything with someone who is.

 

 

Basic:

Stock options are a benefit a company gives to employees. They are rights for employees to buy company stock in the future at a set price. In your wife's example, her company gave her the right to buy 1100 shares in the future at $26.35. The purpose of stock options is to persuade the employee to stick around and to worker harder to push the earnings and hence stock price above the options price. The price at which you can buy the shares is called the “exercise” price. It is largely determined by luck (IE the day you join the company, or the day you are granted the stock options), although you can slightly time things when you join a company that has seasonal stock price swings.

 

Now, generally you will have to wait before you can do use these stock options. This is called “vesting”. Typically, companies spell out how long you have to wait before you can exercise a portion of the stock options. Typically, a stock option grant vests over a 4 year period, with the first 25% of the share amount available after 1 year front the date your give the option, and then 25%/12 month to month for the remaining 4 years. NOTE: sometimes this is negotiable, depending on the size of the company and how important you are.So… If your wife’s company stock is currently trading at $125/share don’t go celebrating right now and go on a shopping spree, because chances are she has to wait at least 1 year before she can do anything with them…and a lot can happen in a year…Similarly, if the current stock price is less than $26.35, her options are currently worthless (AKA underwater), but don’t be bummed yet, because she can’t do anything with them until she vests. And even if she vests, companies typically give a few years before you HAVE to do something. Qualcomm for example gives a few years after you vest before you have to exercise the options (otherwise they disappear).

 

 

Tax Consequences:

 

As long as you don’t exercise the stock options, you don’t have tax consequences. The moment you decide to exercise a stock option and buy the company stock, your tax consequences depends on

A) the type of stock option

AND

B) whether you decide to hold on to the stock or sell it.

 

 

 

There are two types of stock options

Non-qualified Stock Options (NQ)

Incentive Stock Options: (ISO)

 

The tax consequences are different for the different type of options

 

1) Non Qualified are the easiest to understand.

 

Let’s use a hypothetical example.

 

*Let’s say your wife exercises her stock options 1/1/2008 at $26.35/shares and 10000 shares.

*The day she exercise (1/1/2008), the stock prices is $56.35/shares.

 

 

Regardless of whether she holds onto the stock or sells it right away, the difference between the fair market value the day she execised and the stock option price will be taxed at ordinary income and should appear on a W2.

That is $56350-26350= $30000 will be taxed as ordinary income.

 

Now, what happens thereafter depends on when she sells those 10000 shares.

1a) She sells the same day. Well, she has no other tax consequences. The $30000 is all taxed as ordinary income.

1b) She sells the 10000 shares at a later day, but before 1 year. The difference between the stock price the day she sells it and the stock price the day she exercised is taxed as either short term capital gain or loss.

1b1) Let’s say she sells the shares 11/1/2008, and the stock price is $66.35. Recall, the day she exercised her options, the stock price was $56.35. She would have a short term capital gain of ($66.35-$56.35)x10000 , or $10,000 would be taxed as short term capital gains, in addition to the $30,000 she was taxed as ordinary income. This is fair, because in reality, she made $40,000 total.

1b2)Let’s say she sells the shares 11/1/2007 and that day, the stock price is $46.35, below the $56.35 price the day she exercised.

**$30,000 will be taxed as ordinary income tax as before (56.35-26.35) x 10000= $30k .

**$10,000 will be short term capital loss (46.35-56.35)x10000= $10k short term capital loss. …. And here lies the issue. IRS limits the maximum capital loss you can take each year before you have to carry it over to the next year (I think its $3k). So while you have to pay taxes on $30k you really didn’t earn, you can use the $10k capital loss to only offset any other capital gains up to a total $3k of the short term loss that year. You have to carry over the remaining losses next year.

 

 

1c) She sells the 10000 shares after 1 year… You have to pay ordinary income taxes on $30k this year. Then you pay long term capital gain taxes or accrue long term capital losses successive years, similar to 1b1, 1b2. You’re being asked to pay ordinary income taxes up front, but any capital losses in the future are limited to the $3k limit before the remaining amount is carried over to following years.

 

Here’s an article that describes this in detail

http://www.quicken.com/cms/viewers/article/taxes/33890

 

 

2) Incentive Stock Options (ISO) are by far the most complicated, and a lot of people in the Dot Com got burned by AMT with them. Usually, mature companies don’t give out ISO anymore, but in case you run into them…

 

The key difference is that exercising ISO’s are not computed as part of regular income tax. BUT, ISO’s are used in AMT tax (alternative minimum tax). If you don’t know what AMT is, I suggest you read up on it.

 

 

Let’s use a hypothetical example.

 

*Let’s say your wife exercises her ISO stock options 1/1/2008 at $26.35/shares and 10000 shares.

*The day she exercise (1/1/2008), the stock prices is $56.35/shares.

 

*Suppose she decides to hold onto the stock for a year.

While the difference between the market price the day she exercised and her option price x10000 shares (IE $30,000) isn’t subject to ordinary income tax, it WILL be used in computing AMT. AMT tax rates are very interesting…you should expect to pay AMT as large as 28% if the spread between your option price and the Fair Market Value of the stock the day you exercised is very large. (The maximum rate for the AMT is 28%, but the tax resulting from a single large item can be greater than that percentage because of the interaction of various features of the alternative minimum tax.)

 

The second consequence from the AMT adjustment is that some or all of your AMT liability will be eligible for use as a credit in future years. This credit can only be used in years when you don't pay AMT. It's called the AMT credit, but it reduces your regular tax, not your AMT. In the best case, the AMT credit will eventually permit you to recover all of the AMT you paid in the year you exercised your incentive stock option. When that happens, the only effect of the AMT was to make you pay tax sooner, not to make you pay more tax than you would have paid. But for various reasons you can't count on being able to recover all of the AMT in later years.

 

You can avoid this by doing a same day sell on ISO’s. If you do decide to hold on, you should really consult an accountant, because there are other gotchas related to AMT, that I don’t feel competent to explain here.

 

I speak particularly of AMT and ISO, because one of the startups I worked at in the bay area had precisely this issue. We were granted stock options at $30/share pre-ipo. The first day of trading, we closed at $307/share, and a lot of people decided to exercise 10-20k shares that day. Due to lockup of insider shares, they could not trade the first day(90 days, if my memory serves me), and chose to hold on longer than a year for favorable long term cap gains . But thefFollowing year, stock tanked to about $150/share..So a lot of people got screwed ,because they paid a lot of AMT the first year, but could not recover the capital losses (or I should say, they have lifetime capital loss carryover). It financially devastated a lot of people, because they couldnt pay the AMT tax bill.

 

Here's an abbreviated article on what happened to some people. It was quite common. http://irslaw.org/iso_amt.htm

One of the key lessons to learn if your sitting on a wad of in-the-money stock options is don't be greedy, and don't go for that long term cap gains. It might not work to your advantage.

There are other things you want to manage as well, when you are heavily invested in the company you work for. Namely, watch out for have stock options, holding onto ESPP shares, buying company shares in 401k plans, and buying company stock in personal accounts all at the same time. A lot of enron/worldcon/CFC people I'm sure did this, and pissed everything away, and on top of that lost their job. Don't be greedy is the lesson.

Lastly, if you have in-the money stock options that are worth a lot but you haven't fully vested and are afraid that by the time you can vest, you company's stock might be worthless, I would consider hedging the stock options the company grants you buy buying short term put options, provided company policy doesn't forbid you in trading derivatives. Then, the only things that can happen to screw you is if you get dismissed before vesting.

 

[Coronita]

USMCBunny,

 

Sorry for not getting back to you sooner. I've been busy at work. I’ve worked a several companies both here and in the bay area to gone through the entire gamut of stock options.

 

Raybarnes did an excellent job explaining stock options.

I'll try to add additional information to what he said, particularly

regarding taxes. If this gets too confusing, consult a CPA/tax accountant. BTW: I’m not a cpa, so please confirm everything with someone who is.

 

 

Basic:

Stock options are a benefit a company gives to employees. They are rights for employees to buy company stock in the future at a set price. In your wife's example, her company gave her the right to buy 1100 shares in the future at $26.35. The purpose of stock options is to persuade the employee to stick around and to worker harder to push the earnings and hence stock price above the options price. The price at which you can buy the shares is called the “exercise” price. It is largely determined by luck (IE the day you join the company, or the day you are granted the stock options), although you can slightly time things when you join a company that has seasonal stock price swings.

 

Now, generally you will have to wait before you can do use these stock options. This is called “vesting”. Typically, companies spell out how long you have to wait before you can exercise a portion of the stock options. Typically, a stock option grant vests over a 4 year period, with the first 25% of the share amount available after 1 year front the date your give the option, and then 25%/12 month to month for the remaining 4 years. NOTE: sometimes this is negotiable, depending on the size of the company and how important you are.So… If your wife’s company stock is currently trading at $125/share don’t go celebrating right now and go on a shopping spree, because chances are she has to wait at least 1 year before she can do anything with them…and a lot can happen in a year…Similarly, if the current stock price is less than $26.35, her options are currently worthless (AKA underwater), but don’t be bummed yet, because she can’t do anything with them until she vests. And even if she vests, companies typically give a few years before you HAVE to do something. Qualcomm for example gives a few years after you vest before you have to exercise the options (otherwise they disappear).

 

 

Tax Consequences:

 

As long as you don’t exercise the stock options, you don’t have tax consequences. The moment you decide to exercise a stock option and buy the company stock, your tax consequences depends on

A) the type of stock option

AND

B) whether you decide to hold on to the stock or sell it.

 

 

 

There are two types of stock options

Non-qualified Stock Options (NQ)

Incentive Stock Options: (ISO)

 

The tax consequences are different for the different type of options

 

1) Non Qualified are the easiest to understand.

 

Let’s use a hypothetical example.

 

*Let’s say your wife exercises her stock options 1/1/2008 at $26.35/shares and 10000 shares.

*The day she exercise (1/1/2008), the stock prices is $56.35/shares.

 

 

Regardless of whether she holds onto the stock or sells it right away, the difference between the fair market value the day she execised and the stock option price will be taxed at ordinary income and should appear on a W2.

That is $56350-26350= $30000 will be taxed as ordinary income.

 

Now, what happens thereafter depends on when she sells those 10000 shares.

1a) She sells the same day. Well, she has no other tax consequences. The $30000 is all taxed as ordinary income.

1b) She sells the 10000 shares at a later day, but before 1 year. The difference between the stock price the day she sells it and the stock price the day she exercised is taxed as either short term capital gain or loss.

1b1) Let’s say she sells the shares 11/1/2008, and the stock price is $66.35. Recall, the day she exercised her options, the stock price was $56.35. She would have a short term capital gain of ($66.35-$56.35)x10000 , or $10,000 would be taxed as short term capital gains, in addition to the $30,000 she was taxed as ordinary income. This is fair, because in reality, she made $40,000 total.

1b2)Let’s say she sells the shares 11/1/2007 and that day, the stock price is $46.35, below the $56.35 price the day she exercised.

**$30,000 will be taxed as ordinary income tax as before (56.35-26.35) x 10000= $30k .

**$10,000 will be short term capital loss (46.35-56.35)x10000= $10k short term capital loss. …. And here lies the issue. IRS limits the maximum capital loss you can take each year before you have to carry it over to the next year (I think its $3k). So while you have to pay taxes on $30k you really didn’t earn, you can use the $10k capital loss to only offset any other capital gains up to a total $3k of the short term loss that year. You have to carry over the remaining losses next year.

 

 

1c) She sells the 10000 shares after 1 year… You have to pay ordinary income taxes on $30k this year. Then you pay long term capital gain taxes or accrue long term capital losses successive years, similar to 1b1, 1b2. You’re being asked to pay ordinary income taxes up front, but any capital losses in the future are limited to the $3k limit before the remaining amount is carried over to following years.

 

Here’s an article that describes this in detail

http://www.quicken.com/cms/viewers/article/taxes/33890

 

 

2) Incentive Stock Options (ISO) are by far the most complicated, and a lot of people in the Dot Com got burned by AMT with them. Usually, mature companies don’t give out ISO anymore, but in case you run into them…

 

The key difference is that exercising ISO’s are not computed as part of regular income tax. BUT, ISO’s are used in AMT tax (alternative minimum tax). If you don’t know what AMT is, I suggest you read up on it.

 

 

Let’s use a hypothetical example.

 

*Let’s say your wife exercises her ISO stock options 1/1/2008 at $26.35/shares and 10000 shares.

*The day she exercise (1/1/2008), the stock prices is $56.35/shares.

 

*Suppose she decides to hold onto the stock for a year.

While the difference between the market price the day she exercised and her option price x10000 shares (IE $30,000) isn’t subject to ordinary income tax, it WILL be used in computing AMT. AMT tax rates are very interesting…you should expect to pay AMT as large as 28% if the spread between your option price and the Fair Market Value of the stock the day you exercised is very large. (The maximum rate for the AMT is 28%, but the tax resulting from a single large item can be greater than that percentage because of the interaction of various features of the alternative minimum tax.)

 

The second consequence from the AMT adjustment is that some or all of your AMT liability will be eligible for use as a credit in future years. This credit can only be used in years when you don't pay AMT. It's called the AMT credit, but it reduces your regular tax, not your AMT. In the best case, the AMT credit will eventually permit you to recover all of the AMT you paid in the year you exercised your incentive stock option. When that happens, the only effect of the AMT was to make you pay tax sooner, not to make you pay more tax than you would have paid. But for various reasons you can't count on being able to recover all of the AMT in later years.

 

You can avoid this by doing a same day sell on ISO’s. If you do decide to hold on, you should really consult an accountant, because there are other gotchas related to AMT, that I don’t feel competent to explain here.

 

I speak particularly of AMT and ISO, because one of the startups I worked at in the bay area had precisely this issue. We were granted stock options at $30/share pre-ipo. The first day of trading, we closed at $307/share, and a lot of people decided to exercise 10-20k shares that day. Due to lockup of insider shares, they could not trade the first day(90 days, if my memory serves me), and chose to hold on longer than a year for favorable long term cap gains . But thefFollowing year, stock tanked to about $150/share..So a lot of people got screwed ,because they paid a lot of AMT the first year, but could not recover the capital losses (or I should say, they have lifetime capital loss carryover). It financially devastated a lot of people, because they couldnt pay the AMT tax bill.

 

Here's an abbreviated article on what happened to some people. It was quite common. http://irslaw.org/iso_amt.htm

One of the key lessons to learn if your sitting on a wad of in-the-money stock options is don't be greedy, and don't go for that long term cap gains. It might not work to your advantage.

There are other things you want to manage as well, when you are heavily invested in the company you work for. Namely, watch out for have stock options, holding onto ESPP shares, buying company shares in 401k plans, and buying company stock in personal accounts all at the same time. A lot of enron/worldcon/CFC people I'm sure did this, and pissed everything away, and on top of that lost their job. Don't be greedy is the lesson.

Lastly, if you have in-the money stock options that are worth a lot but you haven't fully vested and are afraid that by the time you can vest, you company's stock might be worthless, I would consider hedging the stock options the company grants you buy buying short term put options, provided company policy doesn't forbid you in trading derivatives. Then, the only things that can happen to screw you is if you get dismissed before vesting.

 

[Author]

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