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Wednesday, May 26, 2010

Understanding Stock Option

Question: What is a stock option?

Answer: A stock option is an ability to purchase a specific numbers of shares of a company's stock at a future date at a specific, pre-set price.

Question: What is the pre-set price?

Answer: Called a strike price or a grant price, the pre-set price is usually the price at which the stock is trading on the day the option is issued.

Question: Can I exercise my option (sell my stock) right away?

Answer: No. Stock options have a vesting period, typically 4 to 5 years, during which a proportion of the shares in the option are made available to you. During this vesting period you can sell only the portion of the shares that have vested.

Question: What happens if I leave the company before my options vest?

Answer: You forfeit the stock options.

Question: Does a stock option make me an owner of the company and allow me to vote at the annual meeting?

Answer: No. When a stock option, or part of it, vests, you then have the right to purchase that number of shares. Until you actually purchase the shares, you are not an owner and cannot vote.

Question: Which is better, stock options or restricted stock?

Answer: That depends on the change in the stock price. Generally, if the stock price is going up, stock options are a little better. You can sell both at the higher market value, but with stock options you have not had to commit to the purchase until the stock price reached the point at which you wished to sell. However, if the stock price stays the same or goes down, restricted stock is better. Since you actually own the stock, it retains some value until the stock price goes to zero.

Question: Are restricted stock awards the same size as stock option grants?

Answer: Generally, restricted stock awards are smaller than stock option grants by a factor of two or three (one half or one third the size). If a stock option grant were 100 shares, a restricted stock award would usually range from 33 to 50 shares. This is because at the end of the vesting period the 33 to 50 shares would still have some value and the 100 stock options might not.

Question: Are there tax considerations with stock options?

Answer: Yes. Be sure to consult a qualified accountant.