When we think of compensation the first thing that comes to mind is probably cash. That is the primary way for companies to compensate their employees but it is far from the only way that companies compensate their employees.
In today’s world, many companies also offer their employees a wide range of benefits including healthcare, retirement planning, and incentive stock options.
Most people are familiar with their salary, their healthcare benefits, and their 401k or similar plan, but the stock incentive plan might be a little more foreign to some employees, although these plans can be a game changer for most employees.
What is a Stock Option?
Stock options are an agreement that gives you the right to buy a set number of shares, at a set price, on a set date in the future.
The set price is referred to as the strike price, and the strike price is what will allow you to know whether or not you should exercise your right to buy the shares once you reach the expiration date of the option.
Always keep in mind that options give you the right but not the obligation to purchase shares of a stock. Once you reach the expiration date, you literally have the option to buy shares of the stock at the previously agreed upon price.
Here is An Example.
Say that you are an employee for XYZ corporation and you just found out that as a benefit, they offer you a stock incentive plan. This plan is going to give you the option to purchase shares of XYZ stock at a set price, on a set date in the future.
The agreement is that you have the option to purchase shares of XYZ stock at $10 per share and the expiration date is six months from today.
Ultimately, one of two things can happen over the span of those six months:
- The company could perform well and their stock price will be higher.
- The company performs poorly and the stock price falls below $10 per share.
This is where the option comes in handy for you as an employee.
Remember, as the employee you have the right but not the obligation to purchase those shares for $10 per share.
Assume that in the first scenario, the company performed well and XYZ stock is now worth $15 per share. Would you want to exercise your option to purchase the stock for $10 per share?
Yes! In this case your option gives you the opportunity to buy something that is worth $15 for just $10. That seems like a no-brainer.
On the flip side, what if the company struggled for the past six months and the stock is now worth only $8 per share?
In that case, you would not want to exercise your option to purchase the shares. Why would you pay $10 for something that is only worth $8?
Options Give You Flexibility.
This is only the surface of how exactly stock options work, but in the case of a stock incentive plan for an employee this tells you everything that you need to know.
Stock incentive plans are attractive to employees of a company because it gives them the opportunity to purchase shares of their company at a discounted price.
The plans are also a plus for the companies because the employee benefit could attract better talent, and it also incentivizes their employees to invest their money back into the company.
The bottom line is that stock options allow for flexibility in investing, which generally makes investors more comfortable putting their money behind the company.
