What are stock options? How do these financial instruments used by companies work and what are the advantages for employees who purchase shares offered by the employer.
Stock options: what are these financial instruments used by companies and how do they work?
Understanding the mechanism of this peculiar distribution of company shares granted by employers to their employees and collaborators is useful and interesting to have a more complete picture of all the strategies used by companies to stimulate worker loyalty and incentivize them to achieve company objectives.
From how they work to their specific characteristics to the legislation that regulates them and the taxation currently in force, below is all the useful information to understand what are stock options.
Stock options, what are they? Meaning and definition
When we talk about stock option we are referring first and foremost to a financial instrument that a company can use to encourage a sense of belonging and the participation of workers in the success of the company.
To provide a precise definition, a stock option is an option to purchase company shares at a fixed price and that can be exercised within a certain period of time.
In essence, the company’s employee - or a specific category of employees at the discretion of the company - is offered the possibility (not the obligation) to purchase company shares, either already existing or newly issued.
Stock options follow the functioning of Anglo-Saxon "call options", in that they grant the employee the right to buy company shares within a set period of time (option expiration) and at a specific price (strike price).
In this way, the worker can realize a capital gain, through the purchase of the share at a price equal to or lower than the market price. In short, with stock options, a part of the worker’s salary is tied to the performance of the stock on the market. This is a tool that the company has to stimulate employees on productivity, so that the company has greater profitability and earns more also in terms of share value.
How do stock options work
But how do stock options work in detail? The mechanism has a precise timing.
In the first phase, called granting, the company offers its employees the right to purchase a certain number of shares and also establishes the time frame in which the stock options can be used and the price of the shares.
Then the vesting begins, which is the period between the launch of the stock option offer by the company and the beginning of the exercise of the option right.
Finally, there is the time of exercising, when the option right is actually exercised with the possibility for the employee to purchase the securities.
How stock option plans work
When a company decides to use the stock option tool, it presents a specific plan, which indicates all the terms of operation of the option right on company shares.
Therefore, the stock option plans contain the information necessary for workers to evaluate whether or not to purchase the securities made available by the company. Specifically, the following are established:
- the duration of the stock options;
- the beneficiaries of the option right, who can be identified among all employees or among specific categories (e.g. only managers or only directors);
- strike price: the blocked price of the shares in stock option;
- specific clauses established by the company
In stock option plans, the company can also include “conditions precedent”, that is, performance targets to be achieved and to which the offer of stock options is tied.
Original article published on Money.it Italy. Original title: Cosa sono le stock option e come funzionano
