What is a Stock Option?
A ‘stock option’ refers to employee stock options, which are issued to employees of a particular publicly-traded company as a form of non-cash compensation. An employee stock option is a type of call option that is delivered on the common stock of the underlying company where the employee works.
An employee stock option is a form of compensation; however, unlike a bonus or a raise in the worker’s salary, stock options are based on the underlying stock price of the company. As a result, if the company’s stock rises in share price, the holders of the stock option will experience a direct financial profit. This relationship gives employees a direct incentive to operate in a manner that would benefit the company and in turn boost the firm’s stock price.
An employee stock option is typically offered to management professionals as part of their compensation package. That being said, an employee stock option may also be offered to a non-executive level staff, particularly by businesses that have yet to earn a profit—the underlying company in this situation has limited means to compensate their employees without the issuance of an employee stock option. Furthermore, an employee stock option may be offered to non-employees, such as consultants, supplies, janitorial workers, promoters, and all other individuals who provide services to the company.
The employee stock option is delivered and established similar to warrants, which are call options issued by companies with respect to their underlying stock.
Stock Option Contracts
Stock options are issued as non-standardized calls that are awarded as a private contract between the receiving employee and the issuing employer. Throughout the course of employment, the underlying company will issue the stock option to the employee at a particular price of the established grant day. Typically the employee stock option is delivered to the employee at the company’s current or present day stock price.
All stock options are delivered with a particular vesting schedule and maturity date. Similar to a bond, the maturity date denotes the specific day in which the employee can “cash-in” their investments. Depending on the maturity and vesting schedules, the employee may elect to exercise their stock option at some point, effectively obligating the company to sell the employee its stock at the listed exercise price. At this point, the employee may either hold the stock (in hopes of future appreciation), may sell the stock, or hedge the position with calls or puts.
Differences with Exchange-Traded Options
The exercise price of an employee stock option is non-standardized and is typically delivered to the employee at the current price of the company stock at the direct time of issue.
A standardized stock option is typically delivered in an allotment of 100 shares per contract; in contrast, an employee stock option does not possess a standardized amount.
The number of shares in an employee stock option contract–available for exercise–at the listed strike price will increase over time according to the attached vesting schedule.
An employee stock option has a maximum maturity that exceeds the maturity of standardized options.
Dissimilar to an exchange traded option, all employee stock options are viewed as private contracts between the employer and employee. Because of this relationship, the two parties are responsible for arranging the settlement of the transactions that result from the contract.