What is a stock option?

A stock option is a commitment from the company to allow the grantee (usually an employee) to purchase a certain amount of stock from the company at a fixed price (called the “exercise price”) for a certain period (typically up to 10 years from the date of grant). Shareholders own a piece of the company.  Optionholders are not shareholders (yet).   They own the right to purchase the stock at a given price by a certain time.  Options are usually intended as an incentive to build the value of the company going forward.   The exercise price does not change as the value of the company increases.  So (hopefully) as the value of the company increases, the value to the employee will grow.  If the value of the company remains dormant while the employee holds the option, then there is no significant benefit to the employee.  Employee stock options are usually issued pursuant to a stock option plan approved by the board of directors and the shareholders.  This is primarily because “incentive stock options” — stock options that are eligible for certain favorable tax treatment, must be issued pursuant to a shareholder approved plan.   See What is the difference between incentive stock options and non-qualified stock options.

The grant and exercise of of stock options are subject United States and local laws, including tax and securities laws.  

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