Employee stock options generally are good for a limited duration. There usually is a delay between when a stock option is issued to an employee and when it becomes eligible to be used through a process called vesting. Once an option vests, it often expires after a certain amount of time. Within that window, the timing of when it makes financial sense to use the option depends on stock price fluctuations and tax considerations.
If you have been given stock options as part of your employee compensation package, you will likely be able to cash these out when you see fit unless certain rules have been put into place by your employer detailing regulations for the sale.
How Stock Options Work
Employee stock options give workers at a company the right to buy its stock at a certain price, known as the strike price. That often is the stock price on the date the option is issued, which can be a bargain if the stock's price rises while you work at the company.
Often, as a loyalty incentive, stock options must vest over a period of time before they can be used. Once they vest, an employee can exercise the right to buy the stock at that price, either paying with cash or doing a same-day sale, temporarily borrowing the money for the strike price and then immediately selling the stock for a profit. You often must utilize a stock option or forfeit it when you leave a company.
If a company's stock isn't publicly traded, employees can be restricted by contract to whom they can sell the stock until the company goes public. Some companies might set a minimum amount of time employees need to hold on to the stock before selling it, so you might not be able to cash out your stock options as soon as you exercise them.
If the stock's market value falls below the strike price, there usually is no reason to use the option, since it would be cheaper to simply buy the stock on the open market than buy it with the option. Deciding when to exercise an option before it expires partly involves determining whether you think your company's stock will continue to increase in value, giving you an incentive to hold on to the option later.
For tax purposes, stock options are divided into incentive stock options and non-qualified stock options. Incentive options allow employees to wait to pay tax on the stock options until the employees sell the underlying stock and pay capital gains, rather than ordinary income tax on the proceeds, which usually means a lower tax bill.
With non-qualified stock options, employees must pay ordinary income tax on the difference between the strike price and the market price on the date the option is exercised, even if the employees intend to hold on to the actual stock.
- Key Bank: Employee Stock Options
- The National Center for Employee Ownership: Stock Options
- CNN Money: Exercising Stock Options
- CNN Money: Employee Stock Options
- U.S. Securities and Exchange Commission. "Employee Stock Options Plans." Accessed Feb. 3, 2020.
- Fidelity Investments. "Introduction to Options --The Basics," Page 22. Accessed Feb. 3, 2020.
- Internal Revenue Service. "Topic No. 427 Stock Options." Accessed Feb. 3, 2020.
- Schwab. "Employee Stock Options." Accessed Feb. 3, 2020.
- Financial Industry Regulatory Authority. "The Reality of Investment Risk." Accessed Feb. 3, 2020.
Steven Melendez is an independent journalist with a background in technology and business. He has written for a variety of business publications including Fast Company, the Wall Street Journal, Innovation Leader and Ad Age. He was awarded the Knight Foundation scholarship to Northwestern University's Medill School of Journalism.