How To Trade Stock Options
Today you will hear about stock options in job advertisements in newspapers, magazines and also over the internet. Companies offer stock options to their employees to retain them in the organization. Today stock options are not only provided to people at the senior level but also to employees in the junior level such as rank and file executives.
Stock options enable the employee to buy a specific number of shares of the company in which the employee is working at a price (which is normally discounted) decided by the company. Stock options are provided by public as well as private limited companies. As mentioned before, companies offer stock options to their employees to retain good workers as well as make the employees feel that they are a very important part of the organization. Companies want to hire and retain skilled employees by offering something beyond the normal salary and stock options prove to be the one of the best options amongst the alternatives available.
As mentioned before, the price at which the stock options are available to the employees is discounted. Hence when the price of the shares increases in the market, the employees can earn a good profit after selling them. Unless a company performs badly or goes out of business stock options motivate the employees to stay with the organization and perform better.
We will now discuss as to how employees can trade on stock options. Say for example, a company is giving its employees an option to buy 100 stocks at $10 for each share. The employee can exercise the different options starting from 10th August, 2005. On 10th August the price of the share has risen to $15 a piece. Now the employee has the following options at hand.
- He can sell all the 100 shares at $15 thereby gaining total earnings of $500.
- He can sell part of the shares, say 50 shares at a profit of $5 per share and keep the remaining shares to be sold at a later date when the share prices will increase further.
- He can change all the options that he has into stock and then buy them at a discounted price and then sell the stock at a higher price.
We observe that whatever options the employee decides to take; they have to be converted to stock first. The vesting period has to be taken into consideration by the employees. The employees can buy shares allotted by the company for stock options during the vesting period only. The vesting period is normally spread out over a period of five to ten years.
Let's take an example again. Suppose you get an option of buying 100 shares from your company and the vesting period is spread over five years with one fifth vested for each year. Hence you have the option of buying 20 shares at strike price each year. Hence you can buy shares at a discount each year and then keep them unless the prices rise and then sell them when you are able to get good profits from them.
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