I can't count the number of times I've had friends come up to me and say something like "OK, so I've got the job, I've got the offer, they've given me stock options, but to be honest I'm totally confused".
What's more, a typical stock option contract is painfully confusing if you're not familiar with it.
Let's demystify what is meant by stock options in the context of companies. For example, imagine you receive a job offer that includes stock options or you receive an offer as an existing employee to participate in a stock option grant at work.
PS: there are a number of different models that companies use, such as Restricted Stock Units (RSUs), but today's newsletter is all about stock options.
(Quickly) Explained…
A stock option is a contract that gives the holder the right, but not the obligation, to buy or sell a specified number of shares in a company at a fixed price (known as the strike price) within a specified period of time.
In the simplest sense and using the diagram above, you might be granted stock options as an employee. For a period of time these options have to vest. Vesting is the period of time that has to pass before you can ‘get your hands on them’. This is to protect your employer and incentivise the employee, i.e. do a good job, enjoy your role, contribute to the company and your employer will reward you (with stock) over time. Once the vesting period is over, you own the shares and you can keep, sell or transfer them.
🦸🏼♀️ Deconstructing the jargon:
🧑🏻💻 Grant date: the date which is the day your options begin to vest (keep reading for explanation of vesting).
🤑 Strike price: The price at which the holder of a stock option can buy or sell the underlying stock.
⏳Vesting: refers to the process of earning ownership over time, rather than receiving it (stock options) all at once.
Call Option: A type of stock option that gives the holder the right, but not the obligation, to buy the underlying stock at the strike price.
Put option: A type of stock option that gives the holder the right, but not the obligation, to sell the underlying stock at the strike price.
👀 Cliff: A period of time during which the employee is not entitled to any stock options until a specific date is reached. It serves as a way for companies to incentivise employees to stay with the company for a certain period of time.
🗓️ Expiration date: The date by which a stock option must be exercised or it will expire worthless.
🤑 In-the-money: A stock option is in-the-money if it has intrinsic value, which means that the strike price is favourable compared to the current market price of the underlying stock.
Out-of-the-money: A stock option is out-of-the-money if it has no intrinsic value, which means that the strike price is not favourable compared to the current market price of the underlying stock.
Exercise: The act of using a stock option to buy or sell the underlying stock at the strike price.
Stock options…in 0:1:13 mins
The difference between a stock purchase and stock options
💁♂️Tips and tools
This offer calculator from compound is super helpful. It allows you to play around with your stock options and evaluate your offering. And if you’re based outside of the US, Ledgy’s calculator is also great.
Also, this is a nifty tool to figure out what you might walk away with if you consider tax implications once you exercise your stock options.
Thank you very much! If you've enjoyed reading this and found it useful, I'd really appreciate it if you'd share it with others who you think might feel the same way. 🙏