Stock options are a type of derivative that give you the right to buy or sell a specific number of shares of stock at some point in the future. Stock options can come directly from the company, or you can purchase them from other traders in the stock market.
Direct Stock Options
Direct stock options are a type of derivative provided by companies that issue stock. These stock options are typically offered to employees as an incentive for performance, and employers may provide top-level executives with stock options as part of a bonus or benefits package. Some companies even provide stock options to lower-level employees, as it helps give them some level of ownership in the company. This encourages employees to stay motivated to help the company grow.
Indirect Stock Options
Indirect stock options are a type of investment tool that can be purchased from other investors. With this type of stock option, an individual who owns shares of stock can offer to sell an option contract to another investor. This contract gives the holder the right to buy the shares at a specified price at some point in the future. Another type of options contract involves the right to sell a certain number of shares at a price in the future.
Incentive Vs. Nonqualified
When dealing with direct stock options, you typically find two different types of contracts. One type of stock option that can be used is the incentive stock option, which typically goes to upper-level executives in a company. This type of stock option qualifies for special tax treatment in that the gains are taxed at capital gains tax rates. Another type of direct stock option is the nonqualified option, which usually is given to lower-level employees; they can be issued at a discount to the stock's trading price.
When you are an employee of a company that offers direct stock options, you typically do not have to pay for the option itself. The option is a bonus for being an employee. When you exercise the stock option and actually buy the stock, you have to come up with the money to purchase the shares. With indirect stock options, you have the pay the investor who sells you the contract an amount of money known as the option premium, and you also have to pay to exercise the option by purchasing the shares at the specified price.
- CNN Money: How to Handle Employee Stock Options
- Optiontradingpedia: Stock Options
- Invest-FAQ.com: Derivatives - Stock Option Basics
- Cboe. "What Happens to My Long Option if I Never Sell or Exercise It?" Accessed June 23, 2020.
- Corporate Finance Institute. "Strike Price." Accessed June 23, 2020.
- Fidelity. "What You Need to Know About Cash-Covered Puts." Accessed June 23, 2020.
- Fidelity. "Selecting a Strike Price and Expiration Date." Accessed June 23, 2020.
Luke Arthur has been writing professionally since 2004 on a number of different subjects. In addition to writing informative articles, he published a book, "Modern Day Parables," in 2008. Arthur holds a Bachelor of Science in business from Missouri State University.