Broadly speaking stock options can take on two forms - options that you trade electronically on a public options exchange and stock options that are granted by a company, which you can exercise in return for shares in that company.
Stock Options - Employee Options and Stock Ownership
This article will explore the later, which are also referred to as Employee Options. Tradeable options calls and puts are generally referred to as Equity Options. Both stock and equity options are a financial asset known as a derivative. Companies issue stock options called Share Options in the UK to their employees, which give the employee the right - but not the obligation - to buy a certain amount of shares in the underlying company at an agreed price at an agreed date in the future.
The agreed price is called the exercise or strike price and the agreed date is the expiration date. The directors of the company decide on an exercise price, which is usually set higher than the current traded share price of the stock. As stock options are almost always European style can only be exercised at the expiration date the idea behind the high strike price is to encourage employees to work harder so the share price performs to reflect this.
Another method companies use to determine the strike price is to base it on the average price of the stock over a given period. For example, a company may grant an employee stock options that expire in 6 months and strike the options at the average price of the stock over that 6 month period. If you're employed by a US company you may have come across these terms before.
They are a sub-classification of employee stock options ESO and related specifically to the amount of tax holders of employee stock options are required to pay. Non Qualified Stock Options NSO are the simplest type of stock options where the employee is required to pay ordinary income tax on the profit.
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The Internal Revenue Code classifies options as NSO's when there specifications do not meet the requirements of an Incentive Stock Option ISO. What employees might not realise is that many employers choose to issue NSO's because as the issuer of the option, the employer can offset the income the employee earns as a tax deduction on company income.Accounting for Stock options Ch 16 p 4 -Intermediate Accounting CPA exam
Incentive stock options that are exercised means that any gains are then classified as long term capital gains and taxed accordingly, rather than taxed as ordinary income tax. S a long term capital gain is taxed at a lower rate. So you've been granted some options on your company and you'd like to know how much the options are worth?
Intrinsic value is the price of the option that you would realize if you exercised the option now. The extrinsic value of an option is also called time value.
As the option has an expiration date attached to it, there is value in that the stock may be trading higher than the current value and therefore be worth more in the future than its current intrinsic value. Because the contract is an "option", you can elect not to exercise your option if the stock is below the strike price - meaning that there is only upside potential.
So the additional time you have for the option to trade higher is valuable to the holder of the option. This all comes down to the volatility of the underlying asset. To estimate a stock's historical volatility you can download my Excel based Stock Volatility Calculator. This tool will grab historical price data from Yahoo given your time parameters and calculate the historical volatility for any timeframe that you choose.
Now that you have the volatility you can use an option calculator to determine the stock option's theoretical price. Here are some examples;. Option Trading Workbook - An Excel based option pricing tool Online Option Calculator - A web based option pricing calculator. Equity options traded electronically are most often priced using a binomial tree pricing model as these options can be exercised prior to the expiration date.
Both models are commonly used in the markets to price options. Ok, so you now have the tools to calculate the theoretical price of a call option, but would you bother? All you would really care about is if the options are in-the-money and if you can exercise them and collect your money.
Once the expiration date passes and the stock price is above the strike price you would just go ahead and exercise the options. This can happen in two ways. Once you tell your company that you'd like to exercise the stock you may be required to take delivery of actually buy the underlying stock. If this is the exercising procedure then make sure you have enough cash to make the purchase.
After you receive the shares in your account you can simply go in the open share market and sell them via a stock broker to realize the profit.
If you don't have the spare cash available to take delivery of the asset you might want to check with your employer if they provide a cashless solution for stock option exercise.
Many companies will do this for their employees. This is the most common outcome for employees who exercise in-the-money stock options - except in cases where the employee prefers to retain ownership of the shares for future growth. Here are a few key differences between company issued stock options and exchange traded options equity options ;. What Determines Early Exercise of Employee Stock Options.
Thinking of the UK, I cannot find an easy answer to a situation I have at work with an american company. Is there such a thing in the UK?
Would I have to pay taxes on the increase of valuation regardeless of exercisign or not? Hope this also helps other people in the UK. Thank you in advance.
What are Stock Options? How is the exercise price calculated? Options What are Options? Where are Options Traded? Option Types Option Style Option Value Volatility Time Decay In-The-Money? Payoff Diagrams Put Call Parity Weekly Options Delta Hedging Options Asset Types Index Option Volatility Option Currency Options Stock Options. Comments 1 peter glastonbury December 21st, at 3: Peter Add a Comment Name.