Editor’s note: A version of this question originally appeared on Reddit.
I just received a job offer and I want to make sure I understand the stock options portion of the offer letter before signing:
“You shall receive 5,000 stock options for shares of company stock that vest over four years at the rate of 25% after your first anniversary and then monthly thereafter. The amount of options and the price of the options will be determined by the board of directors within 90 days of the start of employment, and your grant shall be governed by the stock grant agreement that you will receive at that time.”
Obviously, I won’t know the value of those stock options until the price is determined. But can someone break this down for me? I’ve never been given stock options as part of compensation.
- Anonymous
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Dear Anonymous,
First, congratulations on the new job offer! That’s really exciting, and I hope you’re excited about the opportunity.
It’s smart that you’re taking the time to learn more about stock options — understanding your stock options and building a plan for them will help set you up for future success. Let me attempt to give you a super basic crash course in employee equity:
On the day you start your new job, you begin vesting stock options — unlocking the ability to purchase shares at a specific price once you’ve hit certain milestones at work.
In your case, your employer is giving you a time-based vesting schedule:
- You’ll unlock the ability to purchase 1,250 shares on your 1-year work anniversary
- Every month after your 1-year work anniversary, you’ll unlock the ability to purchase an additional 104 shares
- On your 4-year work anniversary, you will have vested all of your original stock grant, fully unlocking the ability to purchase up to 5,000 shares
That’s the first thing that typically surprises people who are new to stock options — you’re being given the *option* to purchase shares. Plus, every time you decide to purchase shares, you might owe additional taxes on the transaction.
Don’t let that discourage you from buying (i.e. exercising) your stock options: If your company gets acquired or goes public, you could end up seeing positive gains on your investment. Every investment carries risk, so be sure to weigh the benefits and costs if/when you do decide to exercise your shares.
All that said, the language in your job offer looks pretty standard. Most employers fail to give future employees enough information to fully understand their equity grant — it’s something we’re working on fixing here at Secfi.
In the meantime, you should chat with your recruiter about the expected value of your stock options. It’s impossible to know whether 5,000 is a little, or a lot.
If it’s 5,000 shares that are currently worth 10 cents each, you’re sitting on a grand total of $500 worth of startup equity — or roughly $125 in equity per year. On the other hand, if it’s 5,000 shares that are currently worth $20 each, you could be sitting on the equivalent of $100,000 in equity.
Ask your recruiter to share the company’s current stock option strike price, to see roughly how much equity you’re earning with this new job. If the equity compensation seems low, consider negotiating for more equity before you sign.
- Vieje Piauwasdy, Director of Equity Strategy, Secfi
Do you have a question about your stock options? Email us at [email protected]
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FAQs
Stock options aren't actual shares of stock—they're the right to buy a set number of company shares at a fixed price, usually called a grant price, strike price, or exercise price. Because your purchase price stays the same, if the value of the stock goes up, you could make money on the difference.
What are stock options for dummies? ›
What Is a Stock Option? A stock option (also known as an equity option), gives an investor the right—but not the obligation—to buy or sell a stock at an agreed-upon price and date. There are two types of options: puts, which is a bet that a stock will fall, or calls, which is a bet that a stock will rise.
What is the basic knowledge of stock options? ›
An option is a contract that represents the right to buy or sell a financial product at an agreed-upon price for a specific period of time. You can typically buy and sell an options contract at any time before expiration. Options are available on numerous financial products, including equities, indices, and ETFs.
What is the $100000 rule for stock options? ›
The 100K Rule[1] states that employees cannot receive more than $100K worth of exercisable incentive stock options (ISOs) in a calendar year. Any additional ISOs over the $100K threshold are treated as non-qualified stock options (NQOs) in the eyes of the IRS.
How do you explain options to a beginner? ›
An option holder is essentially paying a premium for the right to buy or sell the security within a certain timeframe. If market prices become unfavorable for option holders, they will let the option expire worthless and not exercise this right, ensuring that potential losses are not higher than the premium.
How to make money with options for beginners? ›
In this beginning option trading strategy, the trader buys a put — referred to as “going long” a put — and expects the stock price to be below the strike price by expiration. The upside on this trade can be many multiples of the initial investment if the stock falls significantly.
What is the basic understanding of options trading? ›
Options trading is a type of financial trading that allows investors to buy or sell the right to purchase or sell an underlying asset at a fixed price, at a future date. Options trading operates on the basis that the buyer has the option to exercise the contract but is not under any obligation to do so.
Why buy options instead of stocks? ›
When options are better. Options can be a better choice when you want to limit risk to a certain amount. Options can allow you to earn a stock-like return while investing less money, so they can be a way to limit your risk within certain bounds. Options can be a useful strategy when you're an advanced investor.
Is options trading hard to understand? ›
One of the challenges in options trading is understanding the different strategies and how they can be used to manage risk and generate profit. It's also important to have a solid understanding of market dynamics and how they can impact option prices.
What are options in simple words? ›
An option is a derivative, a contract that gives the buyer the right, but not the obligation, to buy or sell the underlying asset by a certain date (expiration date) at a specified price (strike price).
Example of an Option. Suppose that Microsoft (MFST) shares trade at $108 per share and you believe they will increase in value. You decide to buy a call option to benefit from an increase in the stock's price. You purchase one call option with a strike price of $115 for one month in the future for 37 cents per contract ...
What is a good amount of stock options? ›
With stock-based compensation, employees in an early-stage business are offered stock options in addition to their salaries. The percentage of a company's shares reserved for stock options will typically vary from 5% to 15% and sometimes go up as high as 20%, depending on the development stage of the company.
How much money should you have before trading options? ›
Know Your Main Trading Strategies
| Trading Strategy | Definition | Minimum Capital Suggested |
|---|
| Options Trading | Trading contracts which give the right, but not the obligation, to buy or sell a security at a predetermined price within a specific time frame | $2,000 to $5,000 |
6 more rows20%-25% profits-taking rule
Profit-taking means selling a stock when it reaches a certain price to lock in your profits. There are different ways to make profits in the stock market. One common method is to set a specific percentage, like 10%, 15%, or 20%, as your profit target.
What is the best explanation of an option? ›
An option is a contract giving the buyer the right—but not the obligation—to buy (in the case of a call) or sell (in the case of a put) the underlying asset at a specific price on or before a certain date.
What is the easiest way to explain stocks? ›
A stock represents a share in the ownership of a company, including a claim on the company's earnings and assets. As such, stockholders are partial owners of the company. When the value of the business rises or falls, so does the value of the stock.
