How Do Stock Options Work?

How Do Stock Options Work?

Stock options allow employees to purchase a specified number of shares of the company's stock at a specified price during a certain period of time. A study from the National Center for Employee Ownership states that in 2010, 36 percent of employees owned some type of stock in their companies.

Stock options are not as tricky as they may sound. In fact, investing in stock options can prove to be quite lucrative.

  1. Learn the terminology

    Employees are offered the right to buy a certain number of shares at a specified price, referred to as the "grant" price. There is, however, a waiting period, called the "vesting" period, which may run anywhere from two to five years. An employee must be vested before being able to "exercise" the stock options, which means that the employee has the right to buy the stock.

  2. Know the main ways to purchase the stock

    There are three main ways an employee can exercise his or her stock options:

    • Pay cash
    • Swap employer stock that is already owned by the employee
    • Use the services of a professional stockbroker
  3. Be aware of tax penalties

    If the stock options are not properly exercised, the tax penalties can be severe. Taxes must be paid on any profit made when exercising stock options. Consulting with a tax attorney is advisable in order to avoid any unpleasant surprises when tax time arrives.