Stock Options

Overview

Stock options are an agreement between two parties: the buyer and the seller for the sale and purchase of stocks. It is basically a privilege that is sold by one party to another by means of which the buyer gains the right to either purchase or sell a stock at an agreed price within a particular period of time or at a particular date. However, the important point to be noted is that the buyer of the privilege is not bound to adhere to the agreement. In other words, he/she is not obliged to sell or purchase the stock for which he/she has purchased the rights. Stock options are often used by employers as a method to reward their valued employees.

How it Works

As already specified, stock options are an agreement or a contract between two parties by means of which the seller sells the privilege to the buyer for a specified period of time in order to either purchase or sell stocks at an agreed price tag. If the buyer of the privilege chooses not to exercise his/her right within the agreed time period, then he/she loses the privilege and the opportunity to either purchase or sell stocks as the case may be.

The contract between the parties usually mentions the period for which the privilege is being awarded and the price at which the stock is to be either sold or purchased besides other terms and conditions as mutually agreed upon.

If you own the privilege to buy shares and the current market price of the stock is higher than the agreed upon price, you have a favorable deal at hand that you may consider going ahead with. On the other hand, if the market price of the stock drops below the agreed price, you can just let the stock option expire. If you own the purchase privilege, the case is similar.

Benefits

The main benefit of stock options is that they give you more control over your investment options. Stock options, as opposed to stocks, give you enough time to wait and watch the market conditions before you take the call to either sell or buy. If the market conditions are unfavorable, you are not obliged to take the call and you are, therefore, saved from a potential loss.

For employers offering stock options to their employees, this is a non-cash benefit that can be used to lure potential employees and also retain the existing ones. It is also a way to have stockholders investing in the company for a long period of time. From the employee point of view, it gives them an opportunity to build their investment portfolio and/or plan for their retirement.

Costs

If you are considering stock options, then you will have to pay the other party for the privilege that will let you either sell or buy the stocks in question. Once you have bought the privilege, then you have a specified period of time to exercise your right at an agreed upon price. Only if you go ahead with the deal do you incur further expenses. Otherwise, it is only the price of the stock options that you shelled out.

Timing

As with stocks, stock options are also market condition dependent. Therefore, the timing of your purchase or selling of stock options is as crucial as that of stocks. You should be very vigilant and analytical of the market conditions before going ahead with stock options.