Stock options are a type of financial instrument that allow the holder to purchase a specific amount of company stock at a predetermined price. They are often used as an incentive for employees, as they give the holder the potential to benefit from the increase in value of the company's stock.
Stock options are contracts that give the holder the right, but not the obligation, to buy or sell a certain amount of company stock at a predetermined price. The holder is allowed to purchase the stock at the predetermined price, regardless of the current market price. This means that if the stock increases in value, the holder can benefit from the increase.
The predetermined price is known as the strike price or exercise price, and the amount of stock that can be purchased is known as the option size. Options are usually granted to employees as part of their compensation package. The company will set a vesting period, during which the employee must stay with the company in order to be able to exercise their options.
Options can be either "call options" or "put options". A call option gives the holder the right to purchase the stock at the predetermined price, while a put option gives the holder the right to sell the stock at the predetermined price.
Stock options have been used as a form of compensation since the late 19th century. They were initially used to reward executives and other high-ranking employees, but as the stock market grew, companies began to use them as a way to reward and motivate lower-level employees as well.
In the 1970s, the US Securities and Exchange Commission (SEC) began to regulate the use of stock options, and the concept of "options backdating" emerged. This is when companies granted options to employees with a predetermined date, but the date was set prior to the date the options were actually granted. This allowed the employee to benefit from the increase in value of the stock prior to the option being granted.
Stock options have several features that make them attractive to both companies and employees.
For example, a company may grant an employee 10,000 stock options with a strike price of $10. This means that the employee can purchase 10,000 shares of the company's stock at the predetermined price of $10 per share. If the stock increases in value to $20 per share, the employee can exercise their options and purchase the stock at the lower price of $10 per share, and immediately benefit from the increase in value.
Stock options have both advantages and disadvantages.
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Stock options have been the subject of much controversy in recent years. The practice of backdating options has been widely criticized, as it allows companies to reward employees without having to pay out any cash. In addition, the practice of setting unrealistic strike prices has also been criticized, as it allows employees to benefit from the increase in value of the stock without having to risk any of their own money.
Stock options are closely related to other forms of equity compensation, such as restricted stock units (RSUs) and employee stock purchase plans (ESPPs). RSUs are similar to stock options, but the employee does not have to wait until the option is exercised to benefit from the increase in value of the stock. ESPPs are similar to stock options, but they allow employees to purchase the stock at a discounted price.
Stock options are often used as a way to reward and motivate employees, but they can also be used as a way to raise capital for a company. Companies can issue stock options to investors in exchange for capital, which can then be used to finance the company's operations.
Stock options are a popular form of compensation, but they can be complex and difficult to understand. It is important to understand the risks and benefits of stock options before deciding to accept them as part of a compensation package.