Thursday, August 16, 2007

Taking Stock of Stock Options

Author: Nick
Category: Money
Topics: ,

uh-oh, duneim is down 4, sell sell sell

By Valerie March

For our parents, a job’s value was measured simply by the salary. Fortunately for us savvy, albeit a bit spoiled, future CEOs and presidents, we understand that having a “good” job means more than just having a good income.

Vacation time, tuition reimbursement, liberal health benefits, telecommuting, and two-ply toilet paper in the restrooms are all benefits that add toward your happiness at work. And don’t forget stock options–even though a lot of employees do.

It’s not surprising that most young professionals don’t know much, or anything, about stock options. Along with balancing a checkbook or how to change a tire, investing isn’t actively taught in school.

Deficits in the education system aside, many new professionals forgo taking advantage of their company’s stock option program simply because they don’t know what options are, how to use them, or the potential value they hold.

Just What Are Options?

Simply put, a stock option is an agreement that lets you purchase a set number of shares of a company’s stock at a specific price for a specific amount of time. Is that vague enough for you?

There are actually all sorts of options on all sorts of stocks, market indices (think the S&P 500 or Dow Jones Industrial Average) and commodity items, like oil, gold or even coffee–it’s sort of like betting on horses for guys (and gals) in suits.

To keep befuddlement at bay, for the purpose of this article and talking about stock options with regard to employment benefits, all you need to know is that if your company offers you a stock option, they are giving you an opportunity to buy their stock at a discount at some point in the future.

The goal is to motivate you to work harder and contribute to the company’s success so that its stock will increase in value, then you can cash in your options to buy the stock at a discount. After you buy the stock, you are certainly allowed to hold on to it, but most people simply turn around and sell their shares on the open stock market at the increased price for a profit.

Here’s a real world example mirroring how stock options work. Your parents gave you a beater car when you’re 14 years old. You work to repair, clean and paint the car, but you still can’t drive it until you’re 16. When you get your license, you’re able to drive; but at that point, you can either keep the car and put more work into it to increase the value, or you can sell the car and pocket the cash.

An Awesome Options Examples

Now, let’s look at an example of how stock options work for employees, so that if you’re ever offered them, you can do more than stand there and scratch your head.

You sign on for a new job with Awesome Company and Associates. Good for you!

Awesome Co. is a publicly traded company that uses the stock ticker symbol is AWE. (A ticker symbol simply contains one to five letters to identify a corresponding company’s shares for investors on the open market.) Shares of AWE are currently valued at $50 on the open stock market.

Your Awesome Boss says, “New Awesome employee, based on what our stock is currently worth, we’d like to offer you stock options with a $50 strike price (sometimes known as the “award,” “grant” or “exercise” price) and an expiration date of Jan. 15, 2011.”

The strike price simply indicates that any time before Jan. 15, 2011, you can theoretically cash in your stock options and buy your allotted AWE shares at $50, regardless of what they are actually worth on the open market. (Options expirations can occur in any month, and it will probably depend on your start date.)

Awesome Boss’ Master Plan is that you (and your co-worker drones) will work really hard to make Awesome Co. even more awesome. Investors will take note and start buying up AWE shares, thus driving its value skyward.

Awesome Boss hopes that you will ignore all of the really long, hard hours and stick it out for a couple of years so that you can cash in your options and make a nice profit for yourself because Awesome Boss hopes that, come Jan. 15, 2011, shares of AWE will have increased to, say, $80, thanks to your hard work.

Voila! Awesome Boss has simultaneously motivated you to work harder, while offering you a potential raise that won’t even come from the company’s wallet. Stock options are brilliant!

Well, at least for your company.

Are They Always the Best Option?

The main problem is that stock options are only valuable if, in fact, your company performs well and the stock value increases. If the stock price doesn’t grow much, or even declines, your stock options won’t be worth a toot.

Better said: Don’t bother accepting options if you think your company is a stinker. (But then, if you think your firm is a dog, what are you doing working there?)

By offering stock options, your employer also assumes that you plan to be at least marginally involved in investing. To cash in your stock options, you must have a broker–either a live person or an online account.

These days, online brokers are fairly inexpensive and easy to navigate, but most charge commission fees for every action to buy or sell options and stock. Also keep in mind that you will most likely be taxed on any profit that you make.

And what happens if you hate your job and no amount of stock options or flavored coffee creamers in the break room or casual Fridays is going to help that–can you cash in your options after your leave? Like most employee benefits, if you quit or get fired, your stock options are likely subject to certain limitations; each company is different, so be sure to find that out.

In the same vein, most companies require a “vesting period” before you can cash in on your options. During the vesting period, usually between three to five years, the company wants to ensure that you’re going to stick around and in”vest” in your job, so they prohibit you from cashing in on the stock options.

Don’t Let The Man Get One Over on You

Like anything that is potentially very lucrative, stock options require some work to reap the benefit. If you don’t plan to stay at the company for more than a year or so, it’s probably best not to bother, and only you know if you have the patience or interest to file the paperwork, open a brokerage account, and deal with the issues at tax time.

The truth is, many employers expect their workers to ignore their stock options. They know full well that most people won’t take the little time and effort required to reap their rewards.

Exercising your stock options is one small way you can stick it to The Man.

Or, like Dell employees, you can enroll in the stock options program and just hope your company screws up. Dell is currently under investigation for accounting no-nos, and its employees can’t cash in stock options right now, even if they wanted to. Thus, Dell will pay every eligible employee a nice sum to cover its mishap. Dude, you’re getting some cash.

But generally speaking, company accounting blunders notwithstanding, just like flex time or the company gym, how much you really benefit from stock options is up to you.

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Valerie March writes about trading options for a living, and enjoys her company’s large inventory of flavored coffee creamers. When Valerie’s not working for The Man, she’s busy as an aspiring singer/songwriter. You can check her out at

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