What are Stock Options?

Stock Options Definition

A stock option is the right to buy a particular amount of common shares at a fixed price at a future date over a certain period of time. In other words, it provides the option’s owner the capacity to buy stocks for a particular price at a future date irrespective of what the market price is. It gives you an option as an employee to buy a piece of the company you work for. More specifically, it’s an option to buy a set number of stocks at a set price, at a set future date.

Companies give out stock options on top of salaries as a bonus to keep you motivated to perform. Why stock options and not a higher salary? Because it’s more beneficial for both you and the company.

For example, if you work hard and help the company’s profits to rise, then the value of the company will go up. That means that its stock price will go up. So when you sell your stocks, you will make a profit.

But you’re on the hook.

There is no way to guarantee that your options will equal money.

Second, you can’t exercise your options until your vesting date.

And third, how do you predict the company’s future value and actual exit?

GrowthAdvisor is the only company that can predict the value of your employee stock options up to 10 years into the future.

But don’t fret. We’ll cover everything you wanted to know about Stock Options.

Now, let’s move on to stock options basics.

Stock Options Basics

Let’s take a look at how stocks work. If you read your Stock Options Plan, you’ll see phrases like “Vesting Schedule” and “Strike Price” and the like. Here is what they mean.

What is a Strike Price?

A Strike Price is the same as a Grant Price. It’s the price at which you can purchase stocks. (NOTE: An Exercise Price is a price at which you exercise your options, as mentioned above.) For example, say your company grants you (another way of saying “gives you”) an option to buy 12,000 shares (another way of saying “stocks”) at 10 cents per share. This is your Strike Price. If you look at your Stock Options Plan, you’ll see that you can’t buy shares NOW. You’ll have to wait until your Vesting Date. Which leads us to the Vesting Schedule.

What is a Vesting Schedule?

A Vesting Schedule is the schedule of dates when you can purchase stock. (This is another way of saying “exercise stock options.”) Simply put, the word “vesting” means you can NOW exercise. And the word “exercising” means you pay NOW (or for RSUs, it means you accept NOW) and so you own shares. Typically, it’d be four years before you can purchase stock—purchase all the shares in your grant. That’s a good amount of time for the company to keep you motivated to stay and to help it grow. Also, it’s called a schedule because your shares start “vesting” after a “cliff” (about six months to a year), and then you get some percentage of your shares every month (or every six months) until the end of the vesting schedule when all the shares are vested.

What is an Expiration Date?

An Expiration Date is a date when your stock options expire. It means that you absolutely have to exercise your options before that date. Or they’ll be gone. Poof! Expired.

How Stock Options work

Because stock options are nothing more than a promise of a future gain, companies got creative at making them shiny and attractive to potential employees. After all, why would you work for a promise that’s worth nothing? Think of stock options as a carrot that hangs within reach. The better your work (and the longer you stay at the same company), the closer you get to reaching the carrot.  Of course, you know that at any moment your company can go belly-up, and that carrot will vanish. But you also know that at any moment your company can skyrocket to success, and that carrot will turn to gold—solid gold in your hands. It’s a risky business, yet it’s also exciting. Like a game. Will you lose? Will you win? You don’t know for sure, so… To motivate you to keep reaching for the carrot, companies created many types of stock options and many types of restrictions that have to be met for you to get the carrot (especially if it turns to gold). Plus, different types of stock options could be given to different types of employees—from co-founders, to the first employees, to directors, to senior managers, and to new hires who join the company as it matures. But don’t let the complicated terms intimidate you. At its core, all stock option types are the same. They promise to give you equity (a piece of the company) in exchange for your loyalty and your performance.

The three basic things you need to know about your stock options are:

1. The number of your options;
2. The price of your options;
3. The valuation of your company;

Why should you own Stock Options?

When an early Google employee—a masseuse—cashed in most of her stock options, she became a millionaire. Though when she first got her job, she thought it would be worthless. But because she stuck with it and stayed at Google for five years, she made a TON of money. Of course, not everyone is so lucky. But stock options can be used to build considerable wealth if you know how to use them. On the flip side, if they expire, they’ll be worthless (more on that later). This is why they are crucial to your income. Own stock options, cash in at the right time, invest in a mutual fund and watch your money grow as a huge snowball is pushed down the hill. We like to call this “Fast Growth Snowball Track.” Or don’t own it, have no extra cash to invest in a mutual fund and watch your money barely grow-more like a tiny snowball pushed down the hill. We like to call this “Slow Growth Snowball Track.” This need for income growth confines you to the endless “rat race.” You have to keep working for money, to make more money. The moment you stop working, your income drops.

That’s exactly why you should own stock options. They’ll help you:

• Save years: Instead of working for money, make your money work for you and retire early.
• Create passive income: You can only work for so long. Owning stock options is your best chance to generate massive amounts of extra cash that you can invest and watch it double every 7 years.

That’s what we do at GrowthAdvisor. We show you the accurate value of your stock options, how it will change over time when to cash it in, when and how to negotiate salary and stock options, and which companies will give you the best and the biggest compensation package overall. Plus, every time you’re due for a promotion, we tell you how to ask for more equity. And every time you get a new job, we tell you how to negotiate a bigger compensation package. Now that we answered your burning question “What are stock options?” Let’s take a look at what types of stock options there are.

What are the types of stock options?

All stock options fit into four buckets:

1. Incentive Stock Options (ISOs);
2. Non-Qualified Stock Options (NSOs);
3. Restricted Stock Units (RSUs);
4. Restricted Stock Awards (RSAs);

It sounds like a mouthful, we know. But they’re quite easy to understand. The main differences are in how they’re taxed and when you can exercise them (another way of saying “when you can use them to buy stocks”). Let’s look at each one.

1. What are Incentive Stock Options (ISOs)?

Incentive Stock Options are the most common type of stock options. If you own those, that’s probably what you have. IRS considers ISOs as statutory. That means the difference between the Strike Price and the Exercise Price is taxed as a capital gain (see more below). So you pay less in taxes.

2. What Are Non-Qualified Stock Options (NSOs)?

Non-Qualified Stock Options are not recognized by the IRS as statutory, so you have to pay income tax on the difference in price. That is the difference between the original Strike Price and the price at which you have exercised your options. Since the ordinary income tax is higher than capital gains tax, you end up paying more in taxes.

3. What are Restricted Stock Units (RSUs)?

Restricted Stock Units are pretty much the same as other stock options, except their value is assigned to them when they vest, NOT before (like in regular options). One other difference: while it is an “option” to buy company shares, RSUs are a company’s “promise” to give you the option to accept the shares. Hence, the word “restricted.”

4. What are Restricted Stock Awards (RSAs)?

Restricted Stock Awards are very similar to Restricted Stock Units, except they are “awarded” so you get them right away (no need to wait for a vesting date).

What are the Rewards and Risks of Stock Options?

Stock options can be worth millions. But they can also be worth nothing. To maximize the rewards and minimize the risks, you need to know the likelihood of your employer’s success. After all, you don’t want to accept a smaller salary and a bigger Employee Stock Options amount only to realize four years later that you slaved for nothing. In other words, why accept a lower salary at a company you’re not sure will succeed (and so its stocks might be worthless)? Why not pick a company that can generate you a considerable amount of cash down the road because of a successful exit? That’s exactly what we do at GrowthAdvisor. We find the best companies for you, predicting the likelihood of their successful exits.

NOTE: GrowthAdvisor is the only product that can predict the exit of any company up to 10 years into the future. Use our Option Price Calculator to see how much your Employee Stock Options will be worth if your company goes public vs. if it gets bought.

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How to get more Stock Options

Now that you know how wonderful Employee Stock Options really are, let’s talk about how to get more of them. There are three ways to do it (and GrowthAdvisor can help you with each):

• Negotiate higher overall compensation at your current job;
• Negotiate a large amount of stock options when getting a new job offer;
• Switch to another company that offers more stock options;

Simply use our Negotiation Chart, and you’re golden.

When to exercise stock options?

As we mentioned above, stock options have a vesting schedule. But you don’t need to exercise all your options on the vesting date. You can exercise some. Or you can choose to not exercise any at all. Why? Because you can choose to hold on to them like that Google masseuse did. Wait until their value goes up, and then purchase stock. Then turn around, sell the stock and pocket the difference. And then invest and prosper. Once again, use GrowthAdvisor to set up Valuation Alerts. We’ll tell you how long you need to hold your stock options. And we’ll tell you when to exercise them, to make the most money.

How to use Stock Options to Retire Early

Let us introduce you to our method that we like to call the “Snowball Technique.” The idea is simple. Think back to the time when you were a kid. Did you ever roll a snowball down a hill, to make it pick up more snow so it could get HUGE? If you didn’t do it yourself, you probably heard a story about another kid who did it. The idea is simple.  If you invest $100,000 in a mutual fund, in about 7 years your money will double. And in another 7 years it will double again, getting you to $400,000. It’s like watching your snowball grow bigger because it picks up more snow. But if you invest only $1,000, then in 14 years you’ll have only $4,000. That’s like watching a tiny snowball pick up very little snow. 

How do you get from investing only $1,000 to investing $100,000?

You pick a job at a company that gives you a generous amount of stock options and has the best chance of a successful exit. Simply sign up with GrowthAdvisor (it’s FREE!) and pick any company from our list, and you’re already ahead of most employees. Here is something even better.  Want to get from earning $40K with your Employee Stock Options to earning $1.6MM? Then read this article (see the “Snowball Technique” section).

How to use stock options to make a profit

As mentioned before, the three most important things you need to know are:

1. The amount of your stock options;
2. The price of your stock options;
3. The valuation of your company, and the percentage that you can potentially own;

Why do you need to know this? Because your stock options represent real money. Think again about the stock options definition. You have the right to own a piece of your company. But how large is that piece? How much money would you need to buy it? And how much money will you make if you buy it, then turn around and sell it? Most important of all, when do you sell it? Will it make you the most profit to sell when your options vest? Or will you profit more if you wait? Don’t let these questions confuse you. That’s what we do at GrowthAdvisor. When you sign up, we ask you simple questions and do the calculations for you.

It all comes down to the value of the company and the difference between the Strike Price and the Market Price. 

The problem is, all three fluctuate and are hard to predict.  At GrowthAdvisor we have developed a unique and sophisticated algorithm that analyzes companies’ past performance patterns and predicts all of the above and then some. Here, try it for yourself. It’s free.

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Understanding the math of stock options is good practice. If you know your numbers, you’ll know how to make a profit. If you don’t know your numbers, you won’t know how to make a profit. It’s as simple as that. Whichever way you decide to go—learn the stock options math on your own or let GrowthAdvisor help you—you’re already doing more than many employees.  Yes, the whole business of stock options may seem complex at first, so it’s easy to get confused. Our advice is simple. Focus on the basics. Get started with what you know now. You’ll learn more over time.

Why Choose Stock Options?

Stock options give employees & stakeholders an equity incentive to build the company, feeling of belonging and share in its growth & success. You must have been offered one too. 

Key Benefits for Employees:

• • • Share the success of company through stock holdings
    • Owning company stock gives pride of ownership & motivates to be fully productive.
    • Stock is a tangible representation of how much an employee’s contribution is worth to the employer.
    • The option may offer some special tax treatments.

Key Benefits for Employers:

• • • Offering a stock to best candidate among the pool of talent is the best tool of recruitment & less turn over of employees.
    • Vested stock & profit after exercising the stock boosts employee job satisfaction and financial wellbeing.
    • Financial incentives and share of success helps the company grow & succeed.
    • In some instances,Stock option may be used as a potential exit strategy for the owners.

Excited for owning the company you work for? GrowthAdvisor is the ultimate guide for all your stock options. We crunched data from over 800,000 companies. We came up with a rating system where you can type in the name of your company and see how it rates in comparison to others. The results show you how fast you can get to your ultimate wealth goal.

Final Thoughts

Employee Stock Options are a secret way to get you to prosperity. (Okay, maybe not such a secret way, but you agree that their earning potential is often overlooked.) Yes, they could be worthless. But they could also be worth A LOT. With a little bit of planning and a little bit of help from GrowthAdvisor, you can get the compensation you deserve and the future that you dream about. Ready to get started?

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