An increasingly valuable form of compensation for many individuals who work for privately held or public companies is the opportunity to own company stock. This is often made available through an employee ownership plan. If your employer provides you with this benefit, it’s important for you to understand how the employee stock options work and the most effective ways to take advantage of them.
The opportunity to own shares in the firm you work for can, at times, be extremely valuable. In other circumstances, the actual financial benefit may turn out to be limited. Much depends on the company’s level of success. One of the most appealing aspects of stock options is that it gives you a greater stake in the potential success of the company.
Prices and dates
Before you make any decisions about how to take advantage of stock options, you need to understand the price you will pay for shares of company stock and the timing of those purchases. This is key to determining the ultimate benefit the ESO plan may have to offer. Here are some of the critical terms to understand:
• Strike price. Also known as the grant price or exercise price, this is what you’ll pay to purchase shares of stock utilizing the option. The price and number of shares available to you is specified at the time the company grants the option.
• Market price. This is the current value of a share of stock. It’s important to know at the time you intend to exercise your option to buy company shares.
• Vesting date. After receiving the option, you may have to wait for a specified time period before you can exercise it. When the vesting date passes, you may choose to purchase the stock at the strike price.
• Expiration date. Once the option is fully vested, you may choose to purchase the stock at any time before the expiration date.
The real benefit of holding stock options is the discount you receive on purchasing company stock. This happens when your company’s market share price has risen significantly above the strike price specified in your option. You can derive a meaningful financial benefit as soon as you purchase shares – a concept often referred to as the option being “in the money.”
If the market value of the stock stays below the strike price by the time you reach the expiration date, you may want to let the option expire. In this instance, you could consider purchasing company shares on the open market at the market price.
Once the vesting date is reached, you can purchase shares in several ways. You can pay cash for the actual shares, or you can swap shares of the stock that you already own to cover the purchase cost at the strike price.
If you purchase shares, they become part of your portfolio and your overall financial strategy. As you exercise your stock options, it’s important to make sure you do so with your overall risk tolerance in mind. Holding too much of a single stock in your portfolio increases your exposure to risk and is a possibility if you accumulate significant shares of company stock over time. Review your options with a financial professional who can help you capitalize on the benefits of having an ownership stake in your employer’s firm while maintaining a well-diversified portfolio.
Paula Dougherty is a certified financial planner and private wealth adviser with Ameriprise Financial Services Inc. in Springfield. She can be reached at email@example.com.
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