Job ads in the classifieds mention stock options
more and more frequently. Companies are offering this benefit not just
to top-paid executives but also to rank-and-file employees. What are
stock options? Why are companies offering them? Are employees
guaranteed a profit just because they have stock options? The answers
to these questions will give you a much better idea about this
increasingly popular movement.

Let's start with a simple definition of stock options:

Stock options from your employer give you the right to buy a specific number of shares of your company's stock during a time and at a price that your employer specifies.

Both privately and publicly held companies make options available for several reasons:

• They want to attract and keep good workers.


• They want their employees to feel like owners or partners in the business.


• They
  want to hire skilled workers by offering compensation that goes beyond
  a salary. This is especially true in start-up companies that want to
  hold on to as much cash as possible.

The price the company sets on the stock (called the grant or strike price)
is discounted and is usually the market price of the stock at the time
the employee is given the options. Since those options cannot be
exercised for some time, the hope is that the price of the shares will
go up so that selling them later at a higher market price will yield a
profit. You can see, then, that unless the company goes out of business
or doesn't perform well, offering stock options is a good way to
motivate workers to accept jobs and stay on. Those stock options
promise potential cash or stock in addition to salary.

Let's look at a real world example to help you understand how
this might work. Say Company X gives or grants its employees options to
buy 100 shares of stock at $5 a share. The employees can exercise the
options starting Aug. 1, 2001. On Aug. 1, 2001, the stock is at $10.
Here are the choices for the employee:

• The first thing an
  employee can do is convert the options to stock, buy it at $5 a share,
  then turn around and sell all the stock after a waiting period
  specified in the options' contract. If an employee sells those 100
  shares, that's a gain of $5 a share, or $500 in profit.


• Another
  thing an employee can do is sell some of the stock after the waiting
  period and keep some to sell later. Again, the employee has to buy the
  stock at $5 a share first.


• The last choice is to change all
  the options to stock, buy it at the discounted price and keep it with
  the idea of selling it later, maybe when each share is worth $15. (Of
  course, there's no way to tell if that will ever happen.)

Whatever
choice an employee makes, though, the options have to be converted to
stock, which brings us to another aspect of stock options: the vesting period.
In the example with Company X, employees could exercise their options
and buy all 100 shares at once if they wanted to. Usually, though, a
company will spread out the vesting period, maybe over three or five or
10 years, and let employees buy so many shares according to a schedule.
Here's how that might work:

• You get options on 100 shares of stock in your company.


• The
  vesting schedule for your options is spread out over four years, with
  one-fourth vested the first year, one-fourth vested the second,
  one-fourth vested the third, and one-fourth vested the fourth year.


• This
  means you can buy 25 shares at the grant or strike price the first
  year, then 25 shares each year after until you're fully vested in the
  fourth year.

Remember that each year you can buy 25 shares
of stock at a discount, then keep it or sell it at the current market
value (current stock price). And each year you're going to hope the
stock price continues to rise.

Another thing to know about options is that they always have an
expiration date: You can exercise your options starting on a certain
date and ending on a certain date. If you don't exercise the options
within that period, you lose them. And if you are leaving a company,
you can only exercise your vested options; you will lose any future
vesting.

One question you might have is: How does a privately
held company establish a market and grant (strike) price on each share
of its stock? This might be especially interesting to know if you are
or might be working for a small, privately held company that offers
stock options. What the company does is to fix a price that is related
to the internal value of the share, and this is established by the
company's board of directors through a vote.

Overall, you can
see that stock options do have risk, and they are not always better
than cash compensation if the company is not successful, but they are
becoming a built-in feature in many industries.

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