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Employee Stock Option

A stock option from an employer gives the employee the right to buy a specific number of shares in the company at a fixed price for a certain number of years. Employee stock options come in two basic forms:

Non-qualified stock option - This option can be granted at a discount of the stock's market value. If the employer permits, the stock is transferable to the employee’s children or a charity.

Incentive stock option (ISO) - This option qualifies for special tax treatment. For example, gains may be taxed at the capital gains rate instead of at the higher, ordinary income tax rates.

Most stock options provided by the employer are for a certain period. If the employee does not exercise his/her stock option within that period, then it will lapse automatically. If the employee is leaving the company, he/she can only exercise vested options. All future vesting will be lost with the ending of the employment.

Generally, stock options promise potential cash or stock in addition to salary. Both privately and publicly held companies make options available for several reasons:

  • As an incentive 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.
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