Job Offer - Explain Stock Options [US]
"An option is a financial instrument instrument that gives you the right, but not the obligation, to do some transaction in the future at a given price. An employee stock option is a kind of ""call option"" -- it gives you the right, but not the obligation, to buy the stock at a certain price (the ""exercise price"", usually set as the price of the stock when the option was granted). The idea is that you would ""exercise"" the option (buy the stock at the given price as provided by the option), if the value of the stock is higher than the exercise price, and not if it is lower. The option is gifted to you. But that does not mean you get any stock. If and when you choose to exercise the option, you would buy the stock with your own money. At what time you can exercise the option (and how many shares you can exercise at a given time) will be specified in the agreement. Usually, you can only exercise a particular share after it has ""vested"" (according to some vesting schedule), and you lose the ability to exercise after you no longer work for the company (plus perhaps a grace period), or after the option expires." Its important that you carefully read the agreement, if you accept the job. The options agreement will usually specify the vesting schedule, the strike price, and the number of options you will have.  When you start vesting options, you can choose to buy stock at the strike price. When you do exercise the options, your employer will likely withhold state and federal income tax. The strike price will hopefully be well below the market price.  Unlike stock, when your employment ends, you usually are not able to hold on to your options. There's typically a small window of time in which you can exercise your options. You should read this part of the agreement carefully and plan accordingly. "There are a few other items that you should be aware of when getting options: The strike price is usually determined by an independent valuation of the common shares (called a 409a valuation). This should give you a sense on what the options are worth. Obviously you are hoping that the value becomes many multiple of that. There are two kinds in the US: Non-quals (NQO) and Incentive Stock Options (ISOs).  The big difference is that when you exercise Non-quals, you have to pay the tax on the difference between the ""fair"" market value on the shares and what you paid for them (the strike price).  This is important because if the company is private, you likely can not sell any shares until it is public. With ISOs, you don't pay any tax (except AMT tax) on the gain until you actually sell the shares.  You should know what kind your getting. Some plans allow for early exercise, essentially allowing you to buy the shares early (and given back if you leave before they vest) which helps you establish capital gains treatment earlier as well as avoid AMT if you have ISOs. This is really complicated direction and you would want to talk to a tax professional.  And always a good idea to know how many total shares outstanding in the Company. Very few people ask this question but it is helpful for you to understand the overall value of the options." Since the 2 existing answers addressed the question as asked. Let me offer a warning. You have 10,000 options at $1. You've worked four years and the options are vested. The stock is worth $101 when you get a job offer (at another company) which you accept. So you put up $10k and buy the shares. At this moment, you put up $10K for stock worth $1.01M, a $1M profit and ordinary income.  You got out of the company just in time. For whatever reason, the stock drops to $21 and at tax time you realize the $1M gain was ordinary income, but now the $800k loss is a capital loss, limited to $3000/yr above capital gains. In other words you have $210k worth of stock but a tax bill on $1M.  This is not a contrived story, but a common one from the dotcon bubble. It's a warning that 'buy and hold' has the potential to blow up in your face, even if the shares you buy retain some value.
I am very surprised no one mentioned the Stock Repair Option Strategy which has real benefits and is one of the mainstream Option Strategies. Quote: Who Should Consider Using the Stock Repair Strategy? In a nutshell, you are buying call options with current strike price (at-the-money) and sell call options with higher strike price (out-of-the-money), all with the same expiry dates.  The only reason to also sell call options here is to recover your premium paid for the other call options. If you are comfortable paying that premium, you just buy the call options without selling the others. In case your stock will rise moderately to a price between the two strike prices, your call option will rise together with your stock, so you will be faster to recover your money. This is the main reason it is called Repair. If you have sold any call options, as the price rises, you have to be careful when it reaches the strike price of the options sold, as from there on you will begin incurring losses. It is however exactly the lucky outcome you were hoping for, your stock is higher, and you can buy back those loss making options - then or shortly before. If you didn't sell any options and payed your premium, you don't need to worry at all at this stage. WARNING It should be noted that the Stock Repair Strategy offers no protection for your stock price further falling down. In that case all those options will expire worthless or you can sell back the ones your bought but likely not for much. In order to have the downside protection for your stock, there are other strategies, the simplest one being buying a Put Option at-the-money or slightly lower. That will effectively cut your possible losses to the Option Premium (which is the main use of that option).  Again, if you hate to pay that premium, you can offset it by selling other options that you either hope won't be exercised or take steps to protect you against those. "Being ""Long"" something means you own it.  Being ""Short"" something means you have created an obligation that you have sold to someone else.  If I am long 100 shares of MSFT, that means that I possess 100 shares of MSFT.  If I am short 100 shares of MSFT, that means that my broker let me borrow 100 shares of MSFT, and I chose to sell them.  While I am short 100 shares of MSFT, I owe 100 shares of MSFT to my broker whenever he demands them back.  Until he demands them back, I owe interest on the value of those 100 shares.  You short a stock when you feel it is about to drop in price.  The idea there is that if MSFT is at $50 and I short it, I borrow 100 shares from my broker and sell for $5000.  If MSFT falls to $48 the next day, I buy back the 100 shares and give them back to my broker.  I pocket the difference ($50 - $48 = $2/share x 100 shares = $200), minus interest owed.  Call and Put options.  People manage the risk of owning a stock or speculate on the future move of a stock by buying and selling calls and puts.  Call and Put options have 3 important components.  The stock symbol they are actionable against (MSFT in this case), the ""strike price"" - $52 in this case, and an expiration, June.  If you buy a MSFT June $52 Call, you are buying the right to purchase MSFT stock before June options expiration (3rd Saturday of the month).  They are priced per share (let's say this one cost $0.10/share), and sold in 100 share blocks called a ""contract"".  If you buy 1 MSFT June $52 call in this scenario, it would cost you 100 shares x $0.10/share = $10.  If you own this call and the stock spikes to $56 before June, you may exercise your right to purchase this stock (for $52), then immediately sell the stock (at the current price of $56) for a profit of $4 / share ($400 in this case), minus commissions.  This is an overly simplified view of this transaction, as this rarely happens, but I have explained it so you understand the value of the option.  Typically the exercise of the option is not used, but the option is sold to another party for an equivalent value.  You can also sell a Call.  Let's say you own 100 shares of MSFT and you would like to make an extra $0.10 a share because you DON'T think the stock price will be up to $52/share by the end of June.  So you go to your online brokerage and sell one contract, and receive the $0.10 premium per share, being $10.  If the end of June comes and nobody exercises the option you sold, you get to keep the $10 as pure profit (minus commission)!  If they do exercise their option, your broker makes you sell your 100 shares of MSFT to that party for the $52 price.  If the stock shot up to $56, you don't get to gain from that price move, as you have already committed to selling it to somebody at the $52 price.  Again, this exercise scenario is overly simplified, but you should understand the process.  A Put is the opposite of a Call.  If you own 100 shares of MSFT, and you fear a fall in price, you may buy a PUT with a strike price at your threshold of pain.  You might buy a $48 June MSFT Put because you fear the stock falling before June.  If the stock does fall below the $48, you are guaranteed that somebody will buy yours at $48, limiting your loss.  You will have paid a premium for this right (maybe $0.52/share for example).  If the stock never gets down to $48 at the end of June, your option to sell is then worthless, as who would sell their stock at $48 when the market will pay you more?  Owning a Put can be treated like owning insurance on the stock from a loss in stock price.  Alternatively, if you think there is no way possible it will get down to $48 before the end of June, you may SELL a $48 MSFT June Put.  HOWEVER, if the stock does dip down below $48, somebody will exercise their option and force you to buy their stock for $48.  Imagine a scenario that MSFT drops to $30 on some drastically terrible news.  While everybody else may buy the stock at $30, you are obligated to buy shares for $48.  Not good!  When you sold the option, somebody paid you a premium for buying that right from you.  Often times you will always keep this premium.  Sometimes though, you will have to buy a stock at a steep price compared to market.  Now options strategies are combinations of buying and selling calls and puts on the same stock.  Example -- I could buy a $52 MSFT June Call, and sell a $55 MSFT June Call.  I would pay money for the $52 Call that I am long, and receive money for the $55 Call that I am short.  The money I receive from the short $55 Call helps offset the cost of buying the $52 Call.  If the stock were to go up, I would enjoy the profit within in $52-$55 range, essentially, maxing out my profit at $3/share - what the long/short call spread cost me.  There are dozens of strategies of mixing and matching long and short calls and puts depending on what you expect the stock to do, and what you want to profit or protect yourself from.  A derivative is any financial device that is derived from some other factor.  Options are one of the most simple types of derivatives.  The value of the option is derived from the real stock price.  Bingo?  That's a derivative.  Lotto?  That is also a derivative.  Power companies buy weather derivatives to hedge their energy requirements.  There are people selling derivatives based on the number of sunny days in Omaha.  Remember those calls and puts on stock prices?  There are people that sell calls and puts based on the number of sunny days in Omaha.  Sounds kind of ridiculous -- but now imagine that you are a solar power company that gets ""free"" electricity from the sun and they sell that to their customers.  On cloudy days, the solar power company is still on the hook to provide energy to their customers, but they must buy it from a more expensive source.  If they own the ""Sunny Days in Omaha"" derivative, they can make money for every cloudy day over the annual average, thus, hedging their obligation for providing more expensive electricity on cloudy days.  For that derivative to work, somebody in the derivative market puts a price on what he believes the odds are of too many cloudy days happening, and somebody who wants to protect his interests from an over abundance of cloudy days purchases this derivative.  The energy company buying this derivative has a known cost for the cost of the derivative and works this into their business model.  Knowing that they will be compensated for any excessive cloudy days allows them to stabilize their pricing and reduce their risk.  The person selling the derivative profits if the number of sunny days is higher than average.  The people selling these types of derivatives study the weather in order to make their offers appropriately.  This particular example is a fictitious one (I don't believe there is a derivative called ""Sunny days in Omaha""), but the concept is real, and the derivatives are based on anything from sunny days, to BLS unemployment statistics, to the apartment vacancy rate of NYC, to the cost of a gallon of milk in Maine.  For every situation, somebody is looking to protect themselves from something, and somebody else believes they can profit from it.  Now these examples are highly simplified, many derivatives are highly technical, comprised of multiple indicators as a part of its risk profile, and extremely difficult to explain.  These things might sound ridiculous, but if you ran a lemonade stand in Omaha, that sunny days derivative just might be your best friend..." "Can an employer force a person to take a stock?   From what I understand an employer can only offer stock options, doesn't that mean that the employee has to exercise that option in order for the stock to be valid?  Would it be legal to fire me for refusing a bonus?  Furthermore would owning stock necessarily make you an ""owner"" for the purposes of said law?" According to this article: With an all-stock merger, the number of shares covered by a call option is changed to adjust for the value of the buyout. The options on the bought-out company will change to options on the buyer stock at the same strike price, but for a different number of shares. Normally, one option is for 100 shares of the underlying stock. For example, company A buys company B, exchanging 1/2 share of A for each share of B. Options purchased on company B stock would change to options on company A, with 50 shares of stock delivered if the option is exercised.  This outcome strongly suggests that, in general, holders of options should cash out once the takeover is announced, before the transactions takes place.  Since the acquiring company will typically offer a significant premium, this will offer an opportunity for instant profits for call option holders while at the same time being a big negative for put option holders.  However, it is possible in some cases where the nominal price of the two companies favours the SML company (ie. the share prices of SML is lower than that of BIG), the holder of a call option may wish to hold onto their options. (And, possibly, conversely for put option holders.) "Not necessarily.  The abbreviation ""ESOP"" is ambiguous.  There are at least 8 variations I know of: You'll find references on Google to each of those, some more than others.  For fun you can even substitute the word ""Executive"" for ""Employee"" and I'm sure you'll find more.  Really. So you may be mistaken about the ""O"" referring to ""options"" and thereby implying it must be about options.  Or, you may be right.  If you participate in such a plan (or program) then check the documentation and then you'll know what it stands for, and how it works.  That being said: companies can have either kind of incentive plan: one that issues stock, or one that issues options, with the intent to eventually issue stock in exchange for the option exercise price. When options are issued, they usually do have an expiration date by which you need to exercise if you want to buy the shares. There may be other conditions attached. For instance, whether the plan is about stocks or options, often there is a vesting schedule that determines when you become eligible to buy or exercise. When you buy the shares, they may be registered directly in your name (you might get a fancy certificate), or they may be deposited in an account in your name. If the company is small and private, the former may be the case, and if public, the latter may be the case. Details vary. Check the plan's documentation and/or with its administrators." When your options vest, you will have the option to buy your company's stock at a particular price (the strike price). A big part of the value of the option is the difference between the price that your company's stock is trading at, and the strike price of the option. If the price of the company stock in the market is lower than the strike price of the option, they are almost worthless.  I say 'almost' because there is still the possibility that the stock price could go up before the options expire. If your company is big enough that their stock is not only listed on an exchange, but there is an active options market in your company's stock, you could get a feel for what they are worth by seeing what the market is willing to buy or sell similar exchange listed options. Once the options have vested, you now have the right to purchase your company's stock at the specified strike price until the options expire.  When you use that right, you are exercising the option.  You don't have to do that until you think it is worthwhile buying company stock at that price. If the company pays a dividend, it would probably be worth exercising the options sooner, (options don't receive a dividend).  Ultimately you are buying your company's stock (albeit at a discount).  You need to see if your company's stock is still a good investment. If you think your company has growth prospects, you might want to hold onto the stock.  If you think you'd be better off putting your money elsewhere in the market, sell the stock you acquired at a discount and use the money to invest in something else. If there are any additional benefits to holding on to the stock for a period of time (e.g. selling part to fit within your capital gain allowance for that year) you should factor that into your investment decision, but it shouldn't force you to invest in, or remain invested in something you would otherwise view as too risky to invest in. A reminder of that fact is that some employees of Enron invested their entire retirement plans into Enron stock, so when Enron went bankrupt, these employees not only lost their job but their savings for retirement as well... Good questions. I can only add that it may be valuable if the company is bought, they may buy the options. Happened to me in previous company. "You've described the process fairly well.  It's tough to answer a question that ultimately is 'how is this fair?' It's fair in that it's part of the known risk. And for the fact that it applies to all, pretty equally. In general, this is not very common. (No, I don't have percents handy, I'm just suggesting from decades of trading it's probably occurring less than 10% of the time). Why? Because there's usually more value to the buyer in simply selling the option and using the proceeds to buy the stock. The option will have 2 components,  its intrinsic value (""in the money"") and the time premium. It takes the odd combination of low-to-no time premium, but desire of the buyer to own the stock that makes the exercise desirable."